If he does not comply with the demand, the army may be forced to impose martial law. Earlier this week the struggle between President Ghulam Ishaq Khan and Mr Sharif escalated further as they battled for control of the largest and most populous province of Punjab.
Army commanders met for five hours on Thursday. After the meeting the army Chief of Staff, General Abdul Waheed, told Mr Sharif to hold elections under a neutral caretaker government.
Mr Sharif flew to Lahore yesterday to confer with his family and advisers, but he is demanding he be made caretaker prime minister. He was expected to give his reply to the generals late last night.
Politicians from the main parties, among them Benazir Bhutto, have warned of an imminent declaration of martial law. However, so far, Gen Waheed has tried to keep the army neutral, despite numerous attempts by a politician to involve it in the political battle.
The army has spent the past five years, since the death of the dictator Zia ul-Haq, trying to prove its democratic intentions and allowing civilians to rule. Military officers said they were reluctant to take over a political mess and also earn the wrath of the West. However, if Mr Sharif refuses their demands they may have little choice.
On Tuesday, Mr Sharif bulldozed a resolution through parliament for the central government to take over Punjab. Punjab's governor and chief minister, who are loyal to the President, had earlier refused to obey a Punjab High Court order to restore the provincial assembly, which had been dissolved last month.
That night Mr Sharif issued a proclamation saying the President had agreed to the take-over of Punjab. Central government troops came close to a shoot-out with local police forces. The President then accused Mr Sharif of using his name on a proclamation that he had never seen.
Lawyers say Mr Sharif's proclamation is a violation of the constitution and that, in his hurry to grab Punjab, Mr Sharif was prepared to risk civil war. The Prime Minister's hasty move has lost him the moral high ground he had won after being re-instated in office by the Supreme Court on 26 May.