Agencies said soldiers loyal to the Islamic Courts withdrew more than 50km to the southeast from Daynuney, a town just south of Baidoa, the transitional government headquarters.
The retreat along the western front follows the bombing by Ethiopian jets of the country's two main international airports.
"We call on the international community to act soon about this violation"
Sheikh Mohamed Ibrahim Bilal, Islamic courts commander
The Islamic Courts forces also abandoned their main stronghold in Bur Haqaba and were forming convoys headed towards the capital Mogadishu, residents in villages along the road told The Associated Press by telephone.
"We woke up from our sleep this morning and the town was empty of troops, not a single Islamic fighter," Ibrahim Mohamed Aden, a resident of Bur Haqaba said.
Another resident, who asked not to be named, said locals were looting the food stockpile left behind by the Islamic Courts militia.
Fighters were also reportedly retreating on two other fronts in the war for control of Somalia.
On the northern front, government and Ethiopian soldiers entered the town of Bulo Barde, where just two weeks ago a Muslim cleric said anyone who did not pray five times a day would be executed.
An Islamic Courts commander told AFP on condition of anonymity: "There is a lot of pressure from every frontline and in order to overcome this war, Islamic fighters have emptied several posts including Burhakaba and Dinsoor.
"This action is a military tactic, it is a kind of military retreat."
Meanwhile, Abdirahman Dinari, a Somali transitional government spokesman, has called on foreign fighters, believed to be supporting the Council of Islamic Courts, to pull out and allow Somalis to seek ways of restoring peace in their nation, wracked by conflict since the 1991 ousting of Mohamed Siad Barre.
On Tuesday, he said: "We ask all the foreign fighters to pull out of the country and allow Somalis to seek ways of reconciling and establishing peace.
"We strongly appeal to the Islamic Courts to put down arms because the government has made a decision to give them complete amnesty."
On Monday, another government official, Yusuf Dabo Geed, said: "We have taken control of Baladweyne and our forces are chasing the terrorists.
"We have killed more than 60 Islamists, wounded others and captured some as prisoners of war."
|Until last week, Baidoa is the only major town controlled by Somalia's interim government|
Baladweyne is 100km north of Baidoa, seat of the transitional government.
The offensive came after thousands of Ethiopian soldiers prevented the Islamist Courts Union from surrounding and capturing Baidoa, the only major city under government control.
Following their defeat in Baladweyne, leaders of the Islamic Courts called on Ethiopian soldiers to withdraw.
Sheikh Mohamed Ibrahim Bilal, a senior Islamic Courts commander, said: "We call on the international community to act soon about this violation."
Both sides have reported killing hundreds of their opponents in the recent fighting, but the claims could not be independently confirmed.
Also on Monday, Ethiopian fighter jets bombed the airports of Mogadishu and Baledogle, Somalia's largest military airfield, 100km to the west.
Ibrahim Hassan Adow, the foreign secretary of the Islamic Courts, told Al Jazeera that the bombing of Mogadishu by Ethiopian MiG aircraft injured two people, one of whom was a cleaner.
| An anti-aircraft weapon mounted on a truck|
outside Idale, a town 60km from Baidoa [AFP]
Ethiopia said it bombed the airport in order to halt the supply of arms to the courts.
Solomon Abede, the Ethiopian foreign ministry spokesman, said: "It was attacked because illegal flights were attempting to land there.
"It was also reported that some of the extremists were waiting for an airlift out of Mogadishu."
In November, a UN arms-monitoring group reported that flights originating in Eritrea, Saudi Arabia, Iran, Djibouti and Syria landed in Mogadishu and Baledogle.
The UN and the Somali government said that many of the flights carried arms and military supplies for the Islamic Courts. The US has also been accused of funding and arming those fighting for the government.