Israeli troops have killed three Hezbollah fighters during a guerrilla attack near the Lebanese border, which also left several Israelis wounded.
At least 250 blasts shock the border region
It was the heaviest fighting in the Shebaa Farms area since 2000, when Israeli troops left south Lebanon.
Hezbollah fighters launched a major assault on Israeli army posts, triggering retaliatory air strikes.
Israel captured the area from Syria in the 1967 war but it is now claimed by Lebanon with Syria's backing.
Eyewitnesses reported at least 250 explosions in an intense two-and-a-half hours of rocket duels.
Scores of fighters were observed taking part in the Hezbollah operation, which Lebanese security sources said was aimed at taking Israeli hostages.
Israeli aircraft overflew south Lebanon as far north as Tyre, in defiance of repeated calls by the United Nations for an end to violations of Lebanese air space.
Israeli TV said Hezbollah's artillery barrage was designed to divert attention from a raid on the Druze village of Ghajar to capture Israeli soldiers.
Israel has not announced casualty figures from the clashes
The majority of residents in Ghajar are reported to have taken Israeli nationality after Israel captured the Golan Heights from Syria in 1967.
The water-rich Shebaa Farms area lies at the convergence of Lebanon and Syria and the Israeli-occupied Golan Heights.
The UN has ruled that the area belongs to Syria - not Lebanon - and says its fate is linked to the Golan Heights.
In 2004, UN Resolution 1559 called for the disarmament of Hezbollah, but the Lebanese government has so far refused to act.