* African Union threatens targeted sanctions
* Conflict risks sucking in South Sudan's neighbours
By Carl Odera and Aaron Maasho
JUBA, Dec 31 (Reuters) - South Sudanese forces fought rebels on the outskirts of the flashpoint town of Bor on Tuesday, its mayor said, as a deadline imposed by East African nations for an end to hostilities neared.
Two weeks of fighting have killed more than a thousand people in the world's youngest country, raising the spectre of civil war and unnerving oil markets.
The African Union threatened targeted sanctions late on Monday against those inciting the violence and hampering international efforts to negotiate an end to the fighting that risks drawing in the wider region.
"We are fighting the rebels now," Mayor Nhial Majak Nhial told Reuters by phone from the edge of Bor, which lies 190 km (120 miles) to the north of the capital, Juba, by road.
Nhial said he was positioned on the frontline. As he spoke he barked orders to the government soldiers around him.
"Go, go. Do it," he shouted, with sustained volleys of gunfire audible in the background.
The clashes erupted on Dec. 15 with fighting among a group of soldiers in the capital, Juba. The violence quickly spread to half of the country's ten states, cleaving the nation along the ethnic faultline of rebel leader Riek Machar's Nuer group and President Salva Kiir's Dinka.
The scene of a massacre of Dinka in 1991 by Nuer fighters loyal to Machar, Bor is inaccessible to journalists. It was briefly seized by the rebels early in the conflict before being retaken by government troops after several days of heavy fighting.
South Sudan's neighbours have given the warring factions until the end of Tuesday to lay down their arms and begin negotiations - but there has been no sign of the hostilities ending.
Ugandan President Yoweri Museveni said on Monday east African nations had agreed to move in and defeat former Vice President Machar if he rejected a government ceasefire offer. There was no immediate confirmation of the pact from other nations.
But Museveni's words demonstrated the scale of regional worry over the fighting, that has reached some of South Sudan's oil fields, forcing a cut in output.
At a meeting in Gambia in West Africa, the AU said it was dismayed and disappointed by the bloodletting that comes two years after South Sudan won independence from its northern neighbour, Sudan.
"(Council) expresses its intention to take appropriate measures, including targeted sanctions, against all those who incite violence, including along ethnic lines, continue hostilities (and) undermine the envisaged inclusive dialogue," the AU's Peace and Security Council said. (Writing by Richard Lough; Editing by John Stonestreet)