THERE were celebrations throughout Ethiopia yesterday after the country's army captured the strategically valuable town of Zalambessa, advancing to the brink of victory in the two-year-long war against Eritrea.

But despite Eritrea's apparent capitulation to demands for withdrawal from all the territory it captured at the outbreak of war in May 1998, there was still no sign of an imminent end to the fighting.

In the north of the country, MiG fighters roared over the mountains. Transporters hauled T-55 tanks up the winding roads, where there was a constant traffic of lorries with covered cargoes. In little villages, the Ethiopian flag was raised proudly and children followed marching bands singing songs with lyrics such as "Zalambessa my beloved has returned".

Thousands of cheering people turned out in Meskel Square, the main rallying point of the capital, Addis Ababa. A day after confidently predicting victory, Eritrea said that "for the sake of peace" it was complying with a request by the Organisation of African Unity for "de-escalation" and had begun to pull out from several pockets of disputed territory. But Ethiopia said yesterday the move was "a despicable farce" and that there were still large chunks of territory in Eritrean hands.

It said: "The war can only come to an end when Ethiopia has verified that Eritrea has removed its forces of occupation from all the remaining Ethiopian territory under its control." Ethiopians, already flushed with last week's victory on the western front around the town of Badme, awoke yesterday to the news that the central front had also collapsed after a two-day Ethiopian offensive.

The Ethiopian flag was raised in Zalambessa at midnight. The government said: "The Eritrean army was demolished. Those few troops that managed to survive the thrashing are being chased and destroyed by the heroic Ethiopian forces as they run for their lives." In less than two weeks, Eritrea has lost the south-western quarter of its territory. Two Ethiopian armies are converging on the central front with a relatively easy road to the capital, Asmara.

Ethiopians sang in the streets of Addis Ababa at the news from the front in the two-year-old border war between the Horn of Africa neighbours, honking horns and cheering at army trucks.

The capital awoke Thursday morning to state radio playing military music over announcements that Ethiopia's flag was once again flying over Zalambessa, the objective in a fierce two-day assault launched to force an end to the war.

"The Eritrean army was demolished," the government announced.

"Those few troops that managed to survive the thrashing are being chased and destroyed by the heroic Ethiopian forces as they run for their lives."

Even as its troops retreated from their eastern border strongholds, Eritrea insisted the withdrawal was no surrender.

"Things are not what they appear on the ground," presidential spokesman Yemane Gebremeskel declared in the capital, Asmara. "Ethiopia is gaining territory but losing the war."

The Organization of African Unity apparently paved the way for the withdrawal with a face-saving appeal that called on both sides to pull back to their boundaries of May 6, 1998.

Eritrea, after taking reporters to the area Wednesday and showing that it still held Zalambessa, announced overnight that it was accepting the OAU appeal and withdrawing.

"Eritrea has decided, for the sake of peace, to accept the appeal . . . for de-escalation," Eritrea's Foreign Ministry said.

The pullback started at midnight Wednesday in the Zalambessa area, Gebremeskel said.

Ethiopia scoffed at the announcement, saying the claimed withdrawal was a rout by Ethiopian forces.

"As we speak our defence forces are chasing and destroying the fleeing Eritrean army," said Selome Taddesse, government spokeswoman in Addis Ababa.

The government expressed doubt Eritrea would withdraw from all the disputed territory.

Eritrea previously had insisted on a ceasefire before withdrawing, while Ethiopia had demanded a withdrawal before peace talks.

The pledged withdrawal seemed to remove the obstacles on both sides but both said they expected fighting to continue.

"I don't think Ethiopia will go the extra mile so I think the war will continue. If we have to continue fighting, we will defend ourselves," Gebremeskel said.

Eritrea, which achieved independence from Ethiopia seven years ago Wednesday, seized border land in 1998 that it claimed under old colonial-era boundaries.

Fighting over their disputed 1,000-kilometre border has claimed the lives of tens of thousands of soldiers and civilians on both sides. The OAU said this month's offensive alone killed thousands.

Both countries, among the world's 10 poorest, have poured hundreds of millions of dollars into arming and manning the conflict.

The two have been widely accused of neglecting the needs of their people, including in a drought that now threatens lives across the region, to pursue the hostilities. The latest conflict has uprooted an estimated half-million Eritreans, and brought the economy to a standstill.

Envoys from the European Union and the OAU had pressed the countries' leaders for a ceasefire and talks in three days of shuttling between capitals this week.

OAU envoy Ahmed Ouyahia had seemed optimistic Wednesday that Ethiopian leader Meles Zenawi would agree to a reciprocal withdrawal, much of it from land seized in just the past 13 days.

"Prime Minister Meles is definitely in favor of the (deal)," said Ouyahia, the Algerian justice minister. "He says Eritrea will pull back first, then Ethiopia will pull back."

In New York, UN Secretary-General Kofi Annan welcomed Eritrea's action.

Annan "now urges the Ethiopian government also to respond positively to the OAU appeal in order to bring about an immediate end to hostilities, restore the status quo ante of 6 May, 1998, and pave the way for a durable settlement of this tragic conflict," he said in a statement issued in New York.

Ethiopia's latest offensive deep into Eritrea already had retaken other towns and villages in Eritrea's west.

Before the latest outbreak of fighting May 12, both sides had agreed to a framework peace accord drafted by the OAU. But talks to iron out details of the agreement broke down earlier this month.