* Government forces, rebels clash again on outskirts of Bor
* 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 battled rebels on the outskirts of the strategically key town of Bor on Tuesday as a deadline set by east African nations for a ceasefire neared.
Unrest in the world's youngest country has killed more than a thousand people in the past two weeks and displaced close to 200,000, raising the spectre of civil war and unnerving oil markets.
The African Union threatened sanctions late on Monday against those inciting the violence and hampering international efforts to negotiate an end to the fighting, which risks drawing in other countries in eastern Africa.
"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.
South Sudan's neighbours have given the warring sides until Tuesday to lay down their arms and begin talks - but there has been no sign of the hostilities ending. The precise moment the deadline expires is not clear.
The clashes erupted on Dec. 15 with fighting among a group of soldiers in 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.
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 which has reached some of South Sudan's oil fields, forcing a cut in output.
The scene of an ethnic massacre of Dinka in 1991 by Nuer fighters loyal to Machar, Bor was briefly seized by the rebels early in the conflict before being retaken by government troops after several days of heavy fighting.
The "White Army" militia, which was involved in the massacre, had engaged the government soldiers outside the town on Monday, though mayor Nhial said it was not clear whom they were fighting on Tuesday.
Made up of Nuer youths who dust their bodies in white ash, the militia has in the past sided with Machar.
A spokesman for the government of South Sudan's Unity state, controlled by forces loyal to Machar, previously denied Machar was in control of the White Army fighters, raising the prospect that the violence was spreading beyond the control of widely recognised ethnic leaders.
About 70,000 civilians have fled Bor and sought refuge in the town of Awerial in neighbouring Lakes state, with no access to food, clean water or shelter, medical charity Medecins Sans Frontieres (MSF) said. Others were hiding in swamps.
"Living conditions are verging on the catastrophic," MSF said.
Fighting across the country has displaced at least 180,000 people, including 75,000 seeking refuge inside different U.N. bases, according to U.N. figures.
At a meeting on Monday 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)