By Joseph Sipalan

KUALA LUMPUR (Reuters) - Scandal-tainted Malaysian Prime Minister Najib Razak vowed to fight to the end for Malays and Islam on Thursday, as he called on his ruling party to prepare for elections that are "coming soon".

Addressing the annual meeting of the United Malays National Organisation (UMNO), Najib set the tone for early polls and warned of "nightmares" if the ethnic Chinese-dominated Democratic Action Party (DAP) opposition group came to power.

"We pledge to fight to the end and to the last drop of blood, even if our lives are lost," Najib told a cheering crowd.

"Let us realise, my people, not to falter for even a moment as we are faced with challenges that we have never seen before."

The prime minister repeated his support for a bill promoting strict Islamic law, called hudud, adding that it would be taking up for discussion by the federal government.

Najib has been buffeted by graft allegations and faced the biggest challenge to his leadership last year after reports that hundreds of millions of dollars was misappropriated from state fund 1Malaysia Development Berhad (1MDB), which he founded.

Lawsuits filed by the U.S. Justice Department in July said more than $700 million of the misappropriated funds flowed into the accounts of "Malaysian Official 1",  who U.S. and Malaysian officials have identified as Najib.

Najib has denied wrongdoing.

He has shrugged off persistent attempts to unseat him, securing emphatic victories in a state election and two by-elections earlier this year.

But although he retains support of nearly all 200 powerful division chiefs of UMNO's 3.5 million-member organisation, frustration has been growing over graft and a slumping economy.

Tens of thousands of protesters, undeterred by the arrests of opposition leaders and activists, marched in the capital last month demanding that he step down.

"I know, many can feel the heat at this assembly, and are waiting for directives to prepare to battle in the elections that are coming soon," said Najib.

Elections must be called by 2018 but Najib may call for polls in the second half of next year, a government source told Reuters.

Concerns are mounting among Najib's supporters that a new party, led by Najib's mentor-turned-nemesis Mahathir Mohamad and former deputy premier Muhyiddin Yassin, may split the Malay vote.

Najib was particularly critical of Mahathir, who the prime minister said has abandoned the party by consorting with the opposition and pro-democracy group Bersih, among other organisations.

In a racial charged hour-long speech, Najib warned that Islam will be belittled if DAP came to power and Malays must fear the "adverse effects" and "nightmares" that they may face.

"Because of that, the people should keep choosing us forever," Najib said.

(Additional reporting by Emily Chow and Liz Lee; Writing by Praveen Menon; Editing by Nick Macfie)