As the Islamic State group sees city after city slip from its grasp, analysts warn of retaliatory terror attacks in the West and a potential boost for jihadi rival Al-Qaeda.

Iraq forces have already set their sights on Mosul, IS's de facto capital in Iraq, even as they hunt down holdout jihadist fighters in Fallujah, which was declared liberated last week.

The loss of Fallujah -- two years after a military juggernaut that saw IS sweep up territory and proclaim an Islamic caliphate -- comes after months of defeats in Iraq and Syria.

"If they lose their territory they will be weakened but they will be far from finished," said Matthew Henman, the head of IHS Jane's Terrorism and Insurgency Centre.

He said IS was already engaged in damage control among supporters and preparing them for further defeats.

"There has been a fairly noticeable shift in propaganda in the last four to six weeks in terms of preparing its supporters for a loss of territory," Henman said.

He said IS was hammering home the message that even if all their strongholds were lost "this doesn't mean we are going away and the caliphate has been defeated."

- Fighters sent home to Europe -

Henman said IS was likely to send its foreign fighters back to their home countries in Europe and elsewhere "before the net closes... so that as territory falls retaliatory operations can be launched."

He added: "What that does is not only distract from the loss of territory in Iraq and Syria but highlights the group's ongoing ability to project its power despite that loss of territory."

Recent attacks in Orlando and Paris by "lone wolf" IS militants showed the group can keep its global reach alive with little effort, and was likely to step up calls for such attacks as it loses strength, he said.

Brian Michael Jenkins, a terrorism expert with the US-based RAND think tank, said that if losses continue and IS grows increasingly desperate to change the battlefield dynamic, it may launch a "dramatic all-out terrorist offensive (in the hope that) it will draw in a foreign military intervention".

- Going back underground? -

The Pentagon said last month -- before the fall of Fallujah -- that IS has lost about 45 percent of its territory in Iraq, and 16 to 20 percent of land it seized in Syria.

"It's not just that they have lost territory, they have clearly lost people through casualties and desertions (and) they have had their finances squeezed," Jenkins said.

He said one of the group's eventual options would be to return to its roots as an underground operation.

Henman recalled that IS predecessor Al-Qaeda in Iraq (AQI) was "pretty militarily powerful" in the early 2010s even before it had any territory, carrying out several major bombings.

"As and when territory is recaptured the group will recede into the background and it will wait," he said.

"Because unless the Iraqi government fundamentally changes its approach to the relationship it has with its Sunni population there is going to be lingering discontent and animosity that it can exploit," he said.

Iraq is plagued by a deep schism between its Sunni and Shiite populations -- a 14th-century religious divide underlying conflict across the Middle East.

The Shia-dominated government that has ruled Iraq since replacing Saddam's Sunni regime in 2003 faces an uphill battle mending ties with Sunnis sympathetic to extremist groups.

Paris-based Middle East expert Jean-Pierre Filiu warned that in the absence of a viable political alternative for Sunni populations on the ground in both Syria and Iraq, "IS will maintain its positions and could even win back some lost ground".

- Al-Qaeda eyes own emirate -

Once natural allies, Al-Qaeda and IS split in 2014 over strategic differences and have since become bloody rivals in the battle for global jihadi supremacy.

And while IS ponders its next steps, Al-Qaeda and its Syrian affiliate Al-Nusra Front could look to benefit from its losses and possible defections.

"We have seen that among the rank-and-file fighters, loyalties have been fairly fluid, and there isn't this huge ideological difference between the Islamic State and Al-Nusra," said Jenkins.

Charles Lister, a senior fellow at the Middle East Institute, wrote in Foreign Policy magazine last month that Al-Qaeda, harbouring its own dreams of an Islamic emirate, was poised to act on its ambitions.

He said top Al-Qaeda leaders had been transferred into Syria to bolster Al-Nusra's leadership in recent years to lay the groundwork.

"Internally, the Al-Qaeda affiliate remains split on how fast to establish the emirate. In the end developments on the battlefield may play a role in determining the outcome of these debates," Lister wrote.

He warned that only "by empowering local groups opposed to (Al-Qaeda's) transnational jihadi agenda can we avoid gifting northwestern Syria to Al-Qaeda on a silver platter."

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IHS Global Insight