British forces made no attempt to control the crowds on Wednesday, but demonstrators - who gathered outside the main police headquarters - carried banners calling for the return of the two British agents to face Iraqi justice.
"We condemn the illegal acts of British troops," read another banner as demonstrators chanted: "No, no to the occupiers."
They also demanded the resignation of the provincial police chief, accusing him of being an agent of the British.
"The British promised us sovereignty. So where is this sovereignty if they destroy a police station?" asked one demonstrator.
Adding to the crowds anger, two Iraqi citizens who were wounded in clashes between British forces and Iraqi police died in hospital on Wednesday.
Their deaths raise the civilian toll from the incident to five, police said.
On Monday, British troops rammed their way into an Iraqi police station to free two British nationals who had apparently been working undercover.
Both captives had been armed with machine guns and explosives at the time of their arrest and had reportedly shot at an Iraqi patrol to avoid capture.
The UK's Ministry of Defence has declined to say what the pair were doing before their arrest.
The Iraqi police station in Basra
suffered extensive damage
But British troops found that the two men had been handed over to a Shia militia stronghold, which was subsequently raided and the agents freed.
London said its military commander at first tried to negotiate the release of the men on Monday, but this failed when hundreds of demonstrators gathered around the police station, attacking armoured vehicles and setting two on fire.
Reacting to calls for the UK to pull out of Iraq, British Defence Minister John Reid said London would not cut and run and would work to calm local hostility in an increasingly volatile south.
"We do not have designs to stay [in Iraq] as an occupying imperial power. Nor are we going to cut and run because of terrorists," he was quoted as saying by the Daily Telegraph newspaper.
Reid, echoing past comments by British Prime Minister Tony Blair, who has been US President George Bush's main ally on Iraq, said the transformation of the country into a democratic society would not be accomplished without great effort.
"Which is why we have to stay there and go through the dark periods ... there is light at the end of the tunnel," he said.
Britain, which has 8500 troops in Iraq, said on Sunday that it would send more if necessary. But a leaked memo signed by Reid in July envisioned bringing most troops home over the next year.