* Yemeni forces surround mosque held by Saleh loyalists
* Military source says could be launchpad for attacks
* Standoff between current, former presidents escalates (adds Gulf states' endorsement of president)
By Khaled Abdullah
SANAA, June 17 (Reuters) - Yemeni forces have surrounded a sprawling mosque complex in the capital Sanaa amid suspicions that backers of ousted autocrat Ali Abdullah Saleh might use it as a launchpad to attack the presidential palace.
The operation, in its fourth day on Tuesday, is the most dramatic standoff yet between current President Abd-Rabbu Mansour Hadi and Saleh's supporters since he was forced to step down in 2011 following mass protests after 33 years in power.
Gulf neighbours and the West fear for the stability of Yemen, which shares a long border with top oil exporter Saudi Arabia. Riyadh, along with Washington, helped push through the U.N.-mediated political transition.
Dozens of troops in armoured vehicles surrounded the mosque complex which straddles a major highway and is close to the presidential palace where Hadi conducts his day-to-day duties.
Security officials believe the mosque, whose six minarets tower over Sanaa, could be used as a base for insurgents.
"There is information that there's a tunnel leading to the presidential compound from the mosque, and weapons inside the basement," a Yemeni security source told Reuters.
State news agency Saba quoted a source in the presidential guard saying on Monday: "After the arrival of information about the intention by some subversive elements to use the mosque to attack sensitive facilities nearby, guarding has been enhanced to protect the mosque and the surrounding area."
Abdulwali al-Qadi, the head of the mosque and a Saleh relative, denied that the building harboured any weapons.
"There's no truth to these allegations," he told Reuters. "There are no weapons in the basement, only books and Korans."
"The presidency wants us to hand over the mosque. They have no right to ask for that," he said.
Government troops denied media access inside the site.
Elected to lead the impoverished Arabian nation's political transition in 2012, Hadi has sought to chip away at the influence of Saleh and other officials and generals from the old government who diplomats say are seeking to regain power.
The Gulf Cooperation Council, the league of Yemen's energy-rich neighbours who encouraged the deal to oust Saleh, declared on Tuesday its "absolute support for all actions and decisions" taken by Hadi, according to a statement published on Saba.
The mosque was named in Saleh's honour in 2008 and cost tens of millions of dollars to build. Despite upheaval in 2011, it has stayed in the hands of armed guards loyal to the ex-president.
Hadi reshuffled his cabinet on Wednesday - appointing new oil, finance, electricity and foreign ministers - after street protests over deteriorating economic conditions.
A revolt by Shi'ite militants in the north, secessionist unrest in the south and al Qaeda militancy across the country have sapped Yemen's economy, as oil and water resources decline.
The government raided and shut down a pro-Saleh TV channel last week, accusing it of helping stoke unrest.
In a recent interview with Reuters, Saleh said Hadi's "failed government" sought to blame him for its own shortcomings and denied planning a comeback, though he added he wished to remain in politics.
The U.N. Security Council in February authorised sanctions against specific individuals blocking the political transition or committing rights violations. It stopped short of blacklisting anyone, but Western diplomats said Saleh would be a top candidates for any blacklist that was eventually compiled. (Additional reporting by Yara Bayoumy; Writing by Noah Browning; Editing by Robin Pomeroy and Ralph Boulton)
Our Standards: The Thomson Reuters Trust Principles.