The war kicked off a year ago with a six-week ground and air war, and re-erupted last February when tens of thousands of troops were believed to have been killed in bloody trench warfare along the border between the two Horn of Africa countries.

After two months without a significant engagement, both sides reported a battle on their western border at the weekend.

Eritrea said it had ``totally foiled'' an Ethiopian attack close to the Mereb River, killing 380 Ethiopian soldiers and wounding 975. A foreign ministry statement also said Eritrean forces shot down an Ethiopian helicopter gunship.

Ethiopia denied the Eritrean claims as a ``figment of their imagination.'' It said its forces killed more than 400 Eritrean soldiers and wounded 1,500 in a counter-attack after an attack by four Eritrean brigades.

There was no independent confirmation of either claim but diplomats said it was clear that a large engagement had taken place and they feared it marked the start of a fresh round of fighting.

``The mediators have missed the boat in avoiding further fighting,'' said a Western diplomat based in Ethiopia. ``There was some space for diplomatic activity but it was bungled...now we're moving into the third phase of military activity.''

The Organization of African Unity (OAU) has been the chief mediator in the conflict. While both sides in principle accept the OAU's peace plan, they disagree on its interpretation and the peace process has reached a stalemate.

Monday, Eritreans celebrated eight years of independence from their larger southern neighbor, won after a gruelling 30-year guerrilla war.

The U.S. Treasury Department had been planning to forgive the Ethiopian debt -- along with that of a handful of other African nations -- when fighting flared again over a border dispute.

Assistant Secretary of State for African Affairs Susan Rice was asked at a House of Representatives International Relations subcommittee hearing if debt relief was the right message to send to Ethiopia now.

``There have been staff consultations over the course of the last week and the administration has (agreed) to further consult with Congress on the debt relief issue,'' she replied.

Rice, who last year tried to secure an agreement on the withdrawal of forces from the 1,000 km (600 mile)-long border, said the Yugoslav conflict had not distracted the United States from its diplomatic efforts in the Horn of Africa.

``Even as the U.S. focuses on conflicts on other parts of the world, we do not do so to the detriment of our efforts to promote a peaceful resolution to any conflicts in Africa,'' she said.