Israeli troops backed by tanks have taken control of a nine-kilometre area on the edge of the Jabaliya refugee camp in the northern Gaza Strip.
Israel is using lethal force in Gaza
Israeli officials say the move aims to prevent Palestinian militants from firing Qassam rockets into the Israeli town of Sderot.
More than 50 Palestinians, including civilians, have died since Israel began the operation three days ago.
On Saturday, Israeli Prime Minister Ariel Sharon called for an expansion of army operations in Gaza.
The violence continued on Sunday, as witnesses reported two militants from the radical Islamic Jihad movement were killed by Israeli rockets in Jabaliya.
Palestinian militant group Hamas has said there will be no let-up in its attempts to launch missiles from Gaza.
The confrontation at Jabaliya has settled now into a stand-off, says the BBC's Alan Johnston in Gaza.
The Israelis, with their massive presence around the camp, seem content to wait for militant targets to emerge and then they hit hard, our correspondent says.
Two well-known middle-ranking Hamas militants were killed in an explosion in Gaza City on Saturday evening.
Hamas sources identified the men as Mehdi Mushtaha and Khaled Amreet.
Israel has not confirmed the attack - which is similar to many the army has carried out before to target Palestinian militants.
Five Israelis have been killed during the current raids, including a civilian.
The Israeli operation in Gaza began after two children were killed by a rocket in Sderot on Wednesday.
About 2,000 troops, backed by 200 tanks, are taking part in the operation deep into the Jabaliya camp - one of the most densely populated places in the world.
"The nine-kilometre buffer zone is there because the range of the Qassams at this time is around nine kilometres," said Capt Sharon Feingold, an Israeli army spokeswoman.
"So at this time we believe we have dramatically reduced the terrorist organisations' capability to hit an Israeli town and target Israeli children."
In an interview on Saturday evening, Mr Sharon said Israeli troops should go further.
"We must expand the areas of operation to ward off the [militant] launchers from the areas within the firing range of the rocket into Jewish towns over the border," Mr Sharon told Israel Radio.
The Palestinian leadership described Israel's actions as a war crime, and declared a state of emergency.
Palestinian President Yasser Arafat said: "I appeal to the world to ... stop these inhumane and racist crimes."
The US has called on Israel to limit its latest offensive, and France and Russia have voiced deep concern.
On Saturday, Israel released pictures from surveillance aircraft showing three men walking toward a United Nations-marked ambulance, including one who carried an elongated object. The army said the object was a Qassam rocket.
It is not clear whether or not the vehicle was stolen or whether the markings were simply faked. The UN says that it is investigating.
But in a first reaction, the head of the UN agency for Palestinian refugees (UNRWA), Peter Hansen, cast doubt on the Israeli allegations.
Mr Hansen told the BBC the object appeared too light to be carried with one hand - it looked more like a portable stretcher.
He asked Israel to provide more evidence.
The Gaza Strip has been occupied by Israel since it captured the territory in the 1967 war.
Palestinian rocket attacks are complicating Mr Sharon's plans to end Israel's occupation of Gaza, observers say.
Militants are keen to portray any eventual Israeli withdrawal as a retreat under fire, and many expect the violence to escalate.