Palestinian gunmen have attacked an Israeli army post near the Gaza Strip reportedly killing two Israelis before soldiers shot dead three militants.
It is the largest attack since Israeli troops left Gaza
Another Israeli soldier was reported missing after the attack, the worst clash since Israeli troops left Gaza.
Militants tunnelled under the border at Kerem Shalom before attacking with guns and rocket-propelled grenades.
Hours after the raid dozens of Israeli tanks, backed by helicopter gunships, pushed into the Gaza Strip.
Four other Israeli soldiers were injured in the violence, one of them seriously.
There had been reports that the Palestinian militants had seized the body of an Israeli soldier, but Israeli military officials have denied this is the case.
"As far as we know, the soldier is alive," Israeli army chief of staff Dan Halutz said.
A spokesman for Gaza's Popular Resistance Committee said they carried out the attack on the military post in revenge for the death of their leader, Jamal Abu Samhadana, in an Israeli strike.
The armed wing of Palestinian militant group Hamas said its forces aided the attack, using firearms and bombs.
Hamas, currently the governing Palestinian party, ended an informal ceasefire with Israel earlier in June following the deaths of eight members of a Palestinian family on a Gaza beach.
Hamas blamed the beach explosion on shelling from an Israeli warship, a charge Israel has denied.
The BBC's Alan Johnston in Gaza says that if Hamas did participate in this attack it represents a serious escalation in its dealings with Israel.
Close to 20 Palestinian civilians have been killed in Gaza in recent weeks as a result of the Israeli air force's efforts to target militants from groups like Hamas, our correspondent says.
The attack is the largest operation of its kind since Israel withdrew its troops and settlers from Gaza last summer, our correspondent says.
A Hamas spokesman said that the militants had destroyed a tank, but Israeli military sources would not confirm this.
Hamas is due to continue talks later on Sunday with the rival Palestinian Fatah faction to try to end their power struggle and form a united front.