Escalating ambushes, suicide attacks and military clashes have killed more than 700 civilians, soldiers, police and rebels so far this year, raising the spectre of a return to a two-decade civil war that has killed more than 65,000 people since 1983.

Some diplomats believe it is just a matter of time before war reignites. Others feel neither side is ready for a full-blown conflict, and while constantly provoking the military, the Liberation Tigers of Tamil Eelam (LTTE) are eager not to be seen as the ones to start a major conflict.

"The Tigers are moving towards a war state, but not a war involving mass troop movements. We'll see more ambushes, more Tamil civilians being killed, more clashes -- low intensity attrition," said one Western diplomat.

"Grenade attacks are the new peace."

Some analysts believe the Tigers are trying to provoke an ethnic backlash against minority Tamils by the majority Sinhalese, and are using the increasingly tattered 2002 ceasefire to buy time to regroup and rearm.

The Tigers say they are ready to fight a war if one is thrust on them by the government, and told Reuters this month they would resort to all strategies -- including suicide bombings -- if war resumes.

"I don't think there is going to be any dramatic change in the situation in the short run, in spite of a lot of sabre-rattling on the part of the LTTE," said Gerald Peiris, Professor Emeritus at the University of Peradeniya.

Peace Bid Deadlocked

The Tigers pulled out of a fresh round of truce talks in April, and are now insisting that Nordic truce monitors from European Union countries must quit the island by September 1 in light of a new EU terror ban against them. Many fear that could create a dangerous vacuum at a time when attacks are soaring.

"The problem with the ceasefire agreement is that what we normally define as a ceasefire is not what we have in the country today," said Sri Lanka Monitoring Mission (SLMM) spokesman Thorfinnur Omarsson. "Officially there's a ceasefire, but it is violated all the time."

"One could say the ceasefire is in real danger. On the ground it often looks as though there isn't one," he added. "In a situation of full-scale war, you don't need a monitoring mission any more. Our mandate is not to witness a full-scale war."

Ordinary Sri Lankans are increasingly scared. Around 3,000 Tamils have fled to neighbouring India since April, paying smugglers to ferry them across, and the United Nations estimates nearly 40,000 people have been displaced since April.

Business leaders, the Central Bank and even the World Bank have all warned that renewed war could choke the $23 billion (12 billion pound) economy -- forecast to expand 7.0 percent this year.