GORI, Georgia (Reuters) - Russian forces battled pro-Western Georgian troops in South Ossetia on Friday in an escalating conflict that threatens to engulf a key energy transit route to Western Europe.

Both sides ignored pleas from world leaders for calm as Moscow and Tbilisi blamed each other for the fighting in South Ossetia which began after several days of skirmishes. Georgian forces shelled the capital of its breakaway region, which separatists said left 1,400 people dead.

Moscow said its troops were responding to a Georgian assault to retake the region, which broke from Georgia as the Soviet Union was collapsing but has no international recognition.

The crisis, the first to confront Kremlin leader Dmitry Medvedev since he took office in May, with violence flaring in a region seen as a key energy transit route where Russia and the West are vying for influence. The hostilities dampened investor confidence and hit the Moscow stock exchange.

Georgia said Russia bombed airfields and Poti port deep inside its territory and Tbilisi and rushed tanks and troops into South Ossetia, formally still a part of Georgia, to reinforce its small force of peacekeepers.

“If the whole world does not stop Russia today, then Russian tanks will be able to reach any other European capital,” President Mikheil Saakashvili said.

A top Georgian official said Saakashvili was planning to declare martial law within hours, a move that will gives him a free hand to manage the conflict.

The U.N. Security Council held a second meeting on the conflict on Friday, and diplomats said they hoped the council would unanimously call for a ceasefire.

A Reuters correspondent near Gori -- the birthplace of Soviet dictator Josef Stalin between South Ossetia and the Georgian capital -- saw Georgian troops heading back towards Tbilisi on otherwise empty roads, kicking empty ammunition cartons away from their lorries.

Checkpoints usually manned by the international peacekeeping force in the region were abandoned on the darkened road. Two tanks stood unguarded by the roadside. Georgian soldiers said little and appeared exhausted.

RIVAL CLAIMS

The conflict over Georgia’s breakaway regions of South Ossetia and Abkhazia has bedeviled Georgia’s relations with Russia, angered by Tbilisi’s moves towards the Western fold and its pursuit of NATO membership.

Both the Russian-backed separatists and the Georgian government said they were in control of the regional capital Tskhinvali.

“Tskhinvali and the heights around Tskhinvali and the majority of the villages in South Ossetia are under the control of Georgian forces,” Saakashvili said in a televised address.

Irina Galgoyeva, spokeswoman for separatist South Ossetia, denied the report. “The entire town of Tkshinvali is currently controlled by units of South Ossetia’s self-defence,” Russia’s Interfax news agency quoted her as saying.

Political analysts saw Georgia’s bid to re-take its rebel region of South Ossetia by force as a gamble by its leader that Ossetia and Abkhazia, another rebel region on the Black Sea.

“He is in big danger of losing the cachet he built up for himself in being pro-Western and the restraint he has often shown in the face of provocation by Russia,” said James Nixey, of the Royal Institute of International Affairs in London.

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Saakashvili, who wants to take his small Caucasus country in to NATO, has made it a priority to win back control of South Ossetia and Abkhazia, another rebel region on the Black Sea.

Saakashvili said the two countries were at war. The Georgian leader said on television: “What Russia is doing in Georgia is open, unhidden aggression and a challenge to the whole world.

The secretary of Georgia’s Security Council, Kakha Lomaia, said Saakhashvili would impose martial law within hours. Russia, he said, had bombed Georgia’s Black Sea port of Poti and a military base as part of what authorities believed was the start of attacks on civilian targets and infrastructure.

“CEASE ATTACKS”

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U.S. Secretary of State Condoleezza Rice urged Russia to withdraw combat troops from Georgia and stop air strikes.

“We call on Russia to cease attacks on Georgia by aircraft and missiles, respect Georgia’s territorial integrity, and withdraw its ground combat forces from Georgian soil,” she said.

The president of South Ossetia, Eduard Kokoity, told Interfax about 1,400 people had been killed as a result of “Georgian aggression”. Saakashvili put Georgian casualties at about 30, mostly in the military.

President George W. Bush, in Beijing for the opening of the Olympic Games, pledged U.S. support for Georgia’s territorial integrity and called for an immediate ceasefire, the White House said.

Envoys from the United States, European Union and the Organisation for Security and Cooperation in Europe were due to head to Georgia.

EU foreign policy chief Javier Solana said he had spoken to the Russian and Georgian foreign ministers, Sergei Lavrov and Eka Tkeshelashvili, to call for an end to the violence.

The Kremlin said Medvedev told German Chancellor Angela Merkel that “the only possible way out is the withdrawal of Georgian forces to starting positions”.

Soldiers fired machineguns and armored personnel carriers moved through the deserted streets of Tskhinvali.

Shell holes pierced the grey concrete apartment bocks and plumes of smoke hung over the South Ossetian capital.

Lavrov accused the Georgians of driving people from their homes.

The majority of the roughly 70,000 people living in South Ossetia are ethnically distinct from Georgians. They say they were forcibly absorbed into Georgia under Soviet rule and now want to exercise their right to self-determination.