* Gaddafi warns NATO of “catastrophe” if air war goes on
* Tens of thousands of Gaddafi supporters in Green Square
* Gaddafi’s daughter says prepared to cut deal with rebels
* Libya “could be a new Somalia”: World Bank official (Adds AU not to cooperate with ICC arrest warrant for Gaddafi)
By Anis Mili
BIR-AYYAD, Libya, July 1 (Reuters) - Libyan rebels who had advanced to within 80 km (50 miles) of Muammar Gaddafi’s stronghold in the capital were forced to retreat on Friday after coming under a barrage of rocket fire from government forces.
The rebels advanced five days ago to the outskirts of the small town of Bir al-Ghanam, raising the possibility of a breakthrough in a four-month old conflict that has become the bloodiest of the “Arab Spring” uprisings.
Rebel fighters who had been massing on a ridge near Bir al-Ghanam and preparing for an attack were pulled back under fire from Russian-made Grad rockets, said a Reuters photographer in Bir-Ayyad, 30 km to the south.
The rebels returned to the same positions on the edges of Bir al-Ghanam on Friday afternoon, Reuters reporters there said.
The rocket barrage reached as far back as Bir-Ayyad, a road junction in the foothills of the Western Mountains range south-west of Tripoli from where the rebels had launched their advance last week.
The back-and-forth battle underlined the military stalemate between Gaddafi’s forces, who have withstood 15 weeks of bombardment by NATO missiles and warplanes, and rebels attempting to break through their lines on three fronts.
In an address carried by Libyan television and broadcast to some 100,000 supporters who gathered on Friday in Tripoli’s Green Square, Gaddafi vowed to stay on and warned NATO to stop its air war or face defeat.
“We advise you (NATO) to retreat before you face a catastrophe,” Gaddafi told the huge crowd, by far the largest pro-Gaddafi demonstration since a rebellion against his 41-year rule erupted in February.
“I advise you to ground your planes ... and to hold discussions with the Libyan people,” Gaddafi said, denouncing arrest warrants for him, his son and his brother-in-law issued on Monday by the International Criminal Court.
Supporters waved green flags and posters of the Libyan leader, who said the huge turnout was voluntary and proved he was popular among Libyans. Guns were fired into the air and fireworks exploded over the capital at the end of the address.
Two hours after the speech, three explosions were heard and columns of black smoke were seen rising from the direction of Gaddafi’s central Bab Al Aziziya compound in what appeared to be NATO air strikes.
Frustration at the slow progress is growing inside the military alliance, with some members worried about the cost, civilian casualties and the fact the campaign has now been going on much longer than its backers anticipated.
There are also differences about how proactive NATO members should be in aiding the rebels, who are hampered by a lack of organisation and a shortage of equipment.
France this week became the first member of the anti-Gaddafi alliance to acknowledge that it had supplied weapons to the rebels, saying this was justified to protect civilians.
It said it used parachutes to drop assault rifles and rocket launchers, along with humanitarian supplies, to rebels in the Western Mountains.
That admission prompted Russia, a permanent member of the United Nations Security Council, to accuse France of a “gross violation” of a U.N. arms embargo.
Even France’s NATO allies distanced themselves from the French operation, though Britain and the United States said they believed it was justified under U.N. rules.
Libyan television reported late on Friday that NATO had hit sites in the eastern Tripoli suburb of Tajura.
Gaddafi has said the NATO campaign is an act of colonial aggression aimed at stealing Libya’s plentiful oil.
Gaddafi’s daughter, Aisha, said in a television interview broadcast late on Thursday her father’s administration was prepared to cut a deal with the rebels if that was what it took to stop the bloodshed.
“There are direct and indirect negotiations and we should stop letting Libyan blood,” Gaddafi’s daughter said in an interview with France 2 television.
Although her remarks marked a shift in tone, her father again called on his supporters in his audio address to continue fighting the rebels, whom he dismissed as “traitors, a fifth column and mercenaries”.
The London-based Asharq al-Awsat newspaper reported Gaddafi’s representatives had been meeting officials from France and Britain on the Tunisian island of Djerba.
Citing unnamed sources from the Gaddafi and opposition camps, the newspaper said Gaddafi was willing to step down if he was spared prosecution and allowed to live in his hometown of Sirte, northern Libya, with guarantees for his security.
African Union leaders offered on Friday to host talks on a ceasefire and transition to democratic government, but left open whether there was any future role for Gaddafi. There was no immediate reaction from either side to the offer.
A document seen by Reuters at the end of the summit in Equatorial Guinea said member states would not excecute the ICC arrest warrant for Gaddafi, leaving open the possibility that he could go into exile in one of the African Union’s 53 nations.
Anti-Gaddafi rebels rejected talks with the Libyan leader’s regime after the ICC issued its arrest warrants, saying there was no point talking to a war criminal.
Some Libya-watchers say Gaddafi has floated the possibility of a peace deal several times to stall for time and weaken the resolve of the Western alliance to push him out.
But others say he may be looking for a negotiated exit as his options narrow. International sanctions are causing a shortage of fuel in Gaddafi-controlled areas, and NATO strikes are eroding his ability to enforce his power.
The Libyan conflict has sent ripples far beyond the North African country of six million people.
The fighting has halted Libyan oil exports, helping push up world crude prices to about $111 a barrel.
Additional reporting by Tarek Amara and Andrew Hammond in Tunis, David Brunnstrom in Brussels, Lutfi Abu-Aun in Tripoli, Omar Fahmi in Cairo, David Lewis in Malabo, Joseph Nasr in Berlin, Sami Aboudi in Dubai and John Irish in Paris; Writing by Christian Lowe and Joseph Nasr; Editing by Angus MacSwan