Yemen's new prime minister said on Tuesday that an interim government intended to pull the country back from the brink of civil war would be formed in the next 48 hours.

The announcement came as forces opposing and loyal to President Ali Abdullah Saleh pulled back from some positions in the southern city of Taiz, after a bout of fighting there killed at least 20 people.

The violence has threatened to derail the formation of the government, a key element a Gulf-brokered deal to end Saleh's 33-year rule.

Mohammed Basindwa, a former foreign minister representing opposition parties who are to split cabinet posts with Saleh's party, told Reuters he expected the government to be agreed on Wednesday night or the following day.

Basindwa last week said the opposition's commitment to the power transfer depended on ending the bloodshed in Taiz, a hotbed of protests against Saleh.

The Gulf Cooperation Council (GCC), a bloc of Yemen's richer neighbours, shares U.S. fears that the struggle over Saleh's fate could lead to chaos and embolden al Qaeda's Yemeni branch.

On Tuesday the belligerents withdrew from some positions they held in the city, some 200 km (120 miles) south of the capital Sanaa, leaving residents to survey the devastation.

The two sides are fighting a guerrilla war. I lost all three of my businesses in 48 hours, said Mahmoud Hamid Sharaf, a merchant speaking outside his warehouse of computer equipment.

He said fighters from the Republican Guard, a unit led by Saleh's son, had fought from the warehouse before looting it.

The city's security chief acknowledged government troops had caused casualties in the city, but said anti-Saleh fighters were extending the fight.

The use of heavy artillery in the city is wrong but our soldiers are acting in self-defence, sometimes the only way to defend ourselves is to use a suitable weapon used by the others, said Abdullah Qairan.

TAIZ WILL PAY THE PRICE IN BLOOD

Navi Pillay, U.N. High Commissioner for Human Rights, demanded in a statement the government rein its forces in Taiz.

...(D)espite the successive deals and ceasefires, Government security forces continue to use live ammunition against unarmed protestors, the statement said.

A committee tasked with implementing a ceasefire between the two sides moved through streets littered with buses wrecked by artillery shells, heaps of burning rubbish and shops with windows blown out by gunfire and shelling.

We are trying desperately to de-militarise the city, to persuade the army to return to their barracks and the tribesmen to go back to their villages, if this doesn't happen, Taiz will pay the price in blood, a member of the committee said.

The fighting came as the coalition of opposition parties that signed the power transfer deal with Saleh last month said they had agreed on their candidates for an interim government.

Opposition figures have warned formation of a government could founder if the other side puts forth names linked to gross abuses during the attempt to crush protests against Saleh, who would enjoy immunity from prosecution under the transition deal.

The government is to see Yemen through to presidential elections which Abd-Rabbu Mansour Hadi, the vice president to whom Saleh has transferred his powers, has set for February 21.

Any post-Saleh government would face multiple challenges including resurgent separatist sentiment in the south, with which Saleh's north fought a civil war in 1994 following their unification under his rule four years earlier.

The region is the site of conflict between government forces and Islamist fighters who have seized chunks of an entire province, displacing as many as 100,000 people.

(Additional reporting by Tom Finn; Writing By Nour Merza; Editing by Joseph Logan and Maria Golovnina)