Forces loyal to Yemeni President Ali Abdullah Saleh traded artillery fire with tribal foes on the streets of the capital Sanaa on Wednesday, witnesses said, as Prime Minister-designate Mohammed Basindwa prepared to unveil a national unity government.

The fighting in Sanaa, which raged near government buildings and the compound of Sadeq al-Ahmar, an opponent of Saleh commanding significant forces, was the latest challenge to the formation of the government, part of an agreement for Saleh to hand over power after 33 years.

Top oil exporter Saudi Arabia shares U.S. fears that a slide toward more chaos after 10 months of mass protests against Saleh would embolden Yemen's al Qaeda wing, against which Washington has waged a campaign of drone strikes.

Witnesses said shells had fallen on government buildings including the headquarters of state radio and the prime minister's offices as government forces fought Ahmar's men in their stronghold, the capital's Hasaba district.

Militants and army soldiers have been fighting near the Interior Ministry since dawn. They're using machineguns and RPGs, Abdul Rahman, a Sanaa resident, said by phone as gunfire reverberated in the background.

We are trapped in our homes and can't get out, he said. Residents of Sanaa said the streets were nearly empty in the affected districts.

The capital saw open warfare in May between Saleh's forces and those of Ahmar, a leader of the powerful Hashed tribal confederation, after Saleh pulled out of signing the transition deal backed by the Gulf Cooperation Council.

Saleh finally signed the deal last month under pressure from street protests demanding an end to chronic poverty, rampant corruption and lack of economic opportunity. He has formally handed his powers to Vice-President Abd-Rabbu Mansour Hadi.

FIGHTING IN TAIZ

But the deal is threatened by fighting between Saleh's allies and enemies in Taiz, 200 km (120 miles) south of Sanaa, that has left at least 20 dead and led the United Nations to demand that government forces stop shooting protesters.

Basindwa, a former foreign minister nominated to the new unity government by opposition parties, told Reuters that the government line-up would be announced within hours.

One opposition leader said that the Islamist party Islah - Saleh's partner in government in the 1990s before backing protests against him - would get the largest share of the posts allotted to the current opposition, including the interior ministry.

Other opposition parties would get posts including the ministries of finance and trade, according to an agreed list of ministries to be granted to opposition figures that the source, who asked not to be named, showed to Reuters.

Saleh's General People's Congress party had yet to reveal its own names for the new cabinet.

Any new government faces multiple challenges including rising separatist sentiment in the south, which unified with Saleh's north in 1990, but then fought it in a civil war.

The south is also the site of conflict between government forces and Islamist fighters that has displaced tens of thousands of people.

In Yemen's north, new fighting flared on Wednesday between Shi'ite Muslim rebels - who Saleh's forces attempted to crush with Saudi help in 2009 - and Sunni Muslim Salafi Islamists, a Salafi spokesman said.

The Salafis, who espouse a puritanical creed influential in neighbouring Saudi Arabia, have said at least 25 people were killed late last month in attacks by Shi'ite Houthi fighters on a Salafi-run religious school in Saada province on the Saudi border.

The Houthis effectively control the province and are deeply suspicious of the Salafis, who deem Shi'ites heretics. They accuse the Salafis of attempting to build military camps near the border.

(Reporting by Mohammed Ghobari; Writing by Nour Merza; Editing by Kevin Liffey)