"The offensive operation in Muttur has stopped and the LTTE is going back to its former positions in our own territory," a Tiger source told Reuters on condition of anonymity.
According to the same source, the LTTE was pulling back because they want thousands of Muslims who fled their homes on Friday to return.
"It was a limited operation, and we are doing this on humanitarian grounds," the source told Reuters.
Although the Tigers are pulling back a cease-fire has not been reached yet.
"There is no cease-fire," the Tiger source told Reuters.
The government officials said that they would not chase the Tigers but would continue to clear landmines from around a sluice gate, where they say Tigers have blocked the flow of water to farmers in government areas.
A soldier lies wounded in hospital
after a battle with the Tigers
"We are not going to chase them ... We wanted certain areas cleared of terrorists and we have done that," said Keheliya Rambukwella, a spokesman for the ministry of defence.
"Once the last single Tiger leaves [government territory] the firing will stop.But if they come back again we will have to hold the territory and safeguard the civilians," he said.
The government insists it is committed to the 2002 truce, and said that hostilities would stop if the Tigers kept their word. Analysts, however, fear that more clashes are in store.
"The government can play with semantics, but it's hard to see what's going on as anything but a war," said one Western diplomat.
Journalists, who were ferried across Trincomalee harbour to Muttur for the first time since the fighting began, said they could hear mortar and small arms fire after landing on the beach in small assault boats.
"Witnesses said that a suspected army shell hit a Tiger checkpoint as civilians passed through, killing five people"
Rauf Hakeem, a Muslim politician
Along the water line, houses already damaged by the 2004 tsunami stood deserted. The navy camp at the jetty was devastated and just two civilians were seen on the streets.
Aid workers estimate that up to 30,000 civilians fled from Muttur on Friday to escape shelling, several thousand of whom have reached the government-held town of Kantale around 20 miles (30 km) southwest. The military put the number closer to 10,000 to 15,000.
The navy said between 30 and 40 Tiger fighters were moving from house to house in the outer suburbs of Muttur.
Meanwhile, soldiers started to clear the area for those wanting to return, moving from buiding to building to check for booby-traps.
The military said, citing witnesses, that 100 civilians were killed by the Tigers during Friday's civilian exodus.
Military said Tigers had killed 100
civilians during Friday's exodus
Rauf Hakeem, a Muslim politician, said that witnesses told him a suspected army shell had hit a Tiger checkpoint as civilians passed through, killing five people.
The military said that it had killed around 150 Tigers during a battle for control of a jetty in Muttur on Friday, but analysts say the two sides vastly inflate enemy death tolls as a propaganda war rages.
The Tigers say 12 of their fighters were killed during the entire offensive on Muttur.
Well over 800 people have been killed so far this year in escalating attacks and military clashes. The Tigers are furious that President Rajapakse rejected their demand for a separate homeland.
Meanwhile, visiting Norwegian special peace envoy Jon Hanssen-Bauer flew to the island's northern army-held Jaffna peninsula to meet civic leaders, and is due to meet the Tigers' political leadership in their northern base of Kilinochchi on Sunday.
His visit is to discuss the future of Nordic truce monitors after EU member nations decided to pull staff out in the face of a rebel ultimatum after the group was declared a terrorist group by the EU.