* Obama says authorised limited air strikes to curb IS advance
* U.S. planes drop relief supplies to Yazidi refugees
* Sectarian violence continues across Iraq
By Raheem Salman and Matt Spetalnick
BAGHDAD/WASHINGTON, Aug 8 (Reuters) - U.S. President Barack Obama authorised air strikes on Iraq to protect Christians and prevent "genocide" of tens of thousands of members of an ancient sect sheltering on a desert mountaintop from Islamic State fighters threatening to exterminate them.
In Baghdad, where politicians have been paralysed by infighting while the state falls apart, the top Shi'ite cleric all but ordered Prime Minister Nuri al-Maliki to quit, a bold intervention that could bring the veteran ruler down.
The United States began to drop relief supplies to refugees from the ancient Yazidi sect, but there was no sign yet of air strikes, which Obama authorised for the first time since pulling troops out in 2011.
Sunni fighters from the Islamic State, an al Qaeda offshoot bent on establishing a caliphate and eradicating unbelievers, have swept through northern Iraq since June. Their advance has dramatically accelarated in the past week when they routed Kurdish troops defending an autonomous region in the north.
Hundreds of thousands of Iraqi Christians and other minorities have fled from Islamic State fighters who have beheaded and crucified some of their captives and broadcast the killings on the Internet.
The rereat of the Kurds has brought the Islamists to within a half hour's drive of Arbil, the capital of the Kurdish autonomous region and a hub for U.S. and European oil companies who have ordered emergency evacuations of their staff.
"Earlier this week, one Iraqi in the area cried to the world, 'There is no one coming to help'," said Obama in a late night TV address to the nation on Thursday. "Well, today America is coming to help."
"We can act carefully and responsibly to prevent a potential act of genocide," he said.
While the relentless advance of Islamic State fighters has threatened to destroy Iraq as a state, bickering politicians in Baghdad have failed to agree on a new government since an inconclusive election in April.
Maliki, a Shi'ite Islamist whose foes accuse him of fuelling the Sunni revolt by running an authoritarian sectarian state, has refused to step aside for a less polarising figure, defying pressure from Washington and Tehran.
Grand Ayatollah Ali al-Sistani, a reclusive 84-year-old scholar whose word is law for millions of Shi'ites in Iraq and beyond, has repeatedly pushed for politicians to break the deadlock and reunify the country.
His weekly sermon on Friday, read out by an aide, was his clearest call for Maliki to go. Though he did not mention Maliki by name, he said politicians who cling to posts were making a "grave mistake", and leaders must choose a prime minister to end the security crisis.
OIL COMPANIES EVACUATE
Last month, Shi'ite militia and government troops halted the advance of the Islamic State fighters north of Baghdad and on the capitals western and southern ramparts.
Over the past week, the fighters - deploying heavy weapons they seized from fleeing government troops and flush with looted funds - turned against the Kurds, who have ruled themselves in comparitive peace in three mountainous northern provinces while the rest of Iraq was torn by a decade of sectarian bloodshed.
Reuters photographs on Thursday showed the insurgents had raised their black flag over a checkpoint just 45 km (28 miles) from Arbil, a city of 1.5 million which became an oil boomtown when the rest of Iraq was often too dangerous for foreign staff.
U.S. oil majors Exxon Mobil and Chevron evacuated expatriate staff from Iraqi Kurdistan on Thursday, industry sources said. Smaller oil companies that operate in Kurdistan also evacuated staff and cut back operations, and several saw their shares fall sharply on Thursday and Friday.
The Islamists' lightning offensive and the threat of U.S. military action sent shares and the dollar tumbling on world financial markets, as investors moved to safe haven assets such as gold and German government bonds.
Attention has focused on the plights of Yazidis, Christians and other minority groups in northern Iraq, which has been one of the most diverse parts of the Middle East for centuries.
Advancing Islamic State fighters have filmed themselves massacring prisoners. Churches and Shi'ite mosques have been destroyed. Some victims have been crucified, beheaded or dismembered.
Yazidis, ethnic Kurds who practice an ancient faith related to Zoroastrianism, are among a handful of pre-Islamic minority groups who survived for centuries in northern Iraq.
They are believed to number in the hundreds of thousands, most living in a small area of northern Iraq, with small communities scattered in the Caucasus and Europe. Islamic State fighters consider them "devil worshippers".
The U.S. Defense Department said planes dropped 72 bundles of supplies, including 8,000 ready-to-eat meals and thousands of gallons of drinking water, for threatened civilians near Sinjar.
Yazidi lawmaker Mahma Khalil, who is in touch with Yazidis sheltering on Sinjar mountain, said the aid was insufficient.
"We hear through the media there is American help, but there is nothing on the ground," he told Reuters in Baghdad. "Please save us! SOS! save us!" he said several times. "Our people are in the desert. They are exposed to a genocide."
He estimated 250,000 Yazidis were seeking shelter on the arid mountain, which the community considers the holy site where Noah's ark settled after the biblical flood. Other estimates put the number of Yazidi refugees in the tens of thousands.
Obama, who brought U.S. troops home from Iraq to fulfill a campaign pledge, insisted he would not commit ground forces and had no intention of letting the United States "get dragged into fighting another war in Iraq".
Tens of thousands of Iraqi Christians have also fled for their lives after Islamic State fighters overran their hometown of Qaraqosh on Thursday. Numerous Christian denominations have lived in northern Iraq since long before the arrival of Islam.
A United Nations humanitarian spokesman said some 200,000 people fleeing the Islamists' advance had reached the town of Dohuk on the Tigris River in Iraqi Kurdistan and nearby areas of Niniveh province. Tens of thousands had fled further north to the Turkish border, Turkish officials said.
DOUBTS IN WASHINGTON
Questions were quickly raised in Washington about whether selective U.S. attacks on militant positions and humanitarian airdrops would be enough to shift the balance on the battlefield against the Islamist forces.
"I completely support humanitarian aid as well as the use of air power," Republican Senator Lindsey Graham tweeted after Obama's announcement. "However the actions announced tonight will not turn the tide of battle."
The Kurdish regional government insisted on Thursday its forces were advancing and would "defeat the terrorists", urging people to stay calm. Local authorities cut off social media in what one official said was an attempt to stop rumours spreading and prevent panic.
The mood in Arbil on Friday was calm but apprehensive. One resident said some residents had returned home after initially leaving the regional capital in fear of the Islamists' advance.
"Two days ago, people left the city if they had homes in the villages and went there. Now people's state of mind has improved and those who left have returned," said Omaid, a 37-year-old dentist on his way to the market.
Residents were stockpiling food and weapons, he said.
Faced with deep Congressional and public reluctance, Obama backed away from using air power against President Bashar al-Assad's forces in Syria last year after chemical weapons were used. Assad has since regained the upper hand against divided opposition forces in a three-year-old civil war.
However, the president said preventing a humanitarian catastrophe and averting a threat to American lives and interests in Iraqi Kurdistan were ample justification for the use of U.S. military force in Iraq.
Seeking to keep pressure on Maliki, Obama insisted on the need for an Iraqi government that "represents the legitimate interests of all Iraqis" to reverse the militants' momentum.
Neighbouring Iran, which along with Washington had backed Maliki, is working diplomatically to try to find a less polarising figure who can unite Iraq's sectarian factions. Tehran has also sent elite Revolutionary Guard officers to help organise the defence of Baghdad, Iranian sources say.
Obama sent a small number of U.S. military advisers in June in an effort to help the Iraqi government's efforts to fend off the Islamist offensive.
Pope Francis named a special representative for Iraq "in light of the grave situation". Many of the fleeing Iraqi Christians are Chaldean Catholics in communion with the pope. (Additional reporting from Isabel Coles in Arbil and Michael Georgy in Baghdad and Michael Shields in Vienna; Writing by Paul Taylor and Peter Graff, editing by Peter Millership)