Israel's military says four servicemen are missing after one of its vessels off the Lebanese coast was struck by a missile fired by Hezbollah militants.
The ship caught fire after it was hit by either a rocket or explosives-laden drone, the military said.
Hezbollah leader Hassan Nasrallah had earlier promised "open war" on Israel in an address broadcast after his Beirut offices were bombed.
Israel has struck inside Lebanon after Hezbollah captured two Israeli troops.
More than 60 Lebanese have been killed in the offensive.
Hezbollah has not yet confirmed it attacked the warship but in his address Sheikh Nasrallah said: "Look at the warship that has attacked Beirut, while it burns and sinks before your very eyes."
The Israeli military said a civilian vessel was also hit by rockets during the attack but could not confirm its nationality or if there were casualties.
An Israeli spokeswoman said: "During a navy operation off the Lebanese coast a missile ship was hit and we have four crew members missing.
ISRAEL IN LEBANON
March 1978: Israel invades to stop Palestinian attacks
1982: Full-scale invasion; Israel occupies Beirut; pro-Israel militias massacre Palestinian refugees
May 1983: Israel pulls back, but keeps "security zone"
February 1992: Israeli air strike kills Hezbollah leader
1996: Israel launches "Grapes of Wrath" raids on Hezbollah; 100 civilians die under Israeli shelling of UN base at Qana
May 2000: Israel withdraws troops from Lebanon
January 2004: Prisoners-bodies swap agreed between Hezbollah and Israel
"At the moment there are all kinds of operations under way to find them."
The naval incident took place after Israel had launched a number of attacks on Beirut and on Lebanese infrastructure in and outside the capital.
The road to Damascus was hit and Beirut's airport was again targeted on Friday.
Targets in southern Beirut around Hezbollah's headquarters were bombed.
Sheikh Nasrallah was not hurt in the attacks and later said in his broadcast: "You wanted an open war and we are ready for an open war."
He said Haifa would come under attack, "and believe me, even beyond Haifa".
"Our homes will not be the only ones to be destroyed, our children will not be the only ones to die," he said.
Hezbollah has continued rocket attacks on northern Israel - 70 were fired on Friday alone.
A mother and daughter died in an attack on the town of Meron. Two Israelis died in attacks on Thursday.
The UN Security Council held an emergency meeting on Friday and called for an end to the Israeli operation, saying it was causing the death of innocent civilians.
A three-man UN crisis team has arrived in Cairo and will hold talks with the Arab League on Saturday. The situation is also sure to be discussed at the G8 forum in St Petersburg, Russia.
Syria said it would support Hezbollah and Lebanon against Israel's attacks.
A ruling Baath Party statement accused Israel and the US of "trying to wipe out Arab resistance in every land under occupation".
Israel says the campaign will be "long and continuous". Israeli Brig Gen Ido Nehushtan said: "We need to put Hezbollah out of business."
The crisis began when Hezbollah guerrillas seized the two Israeli soldiers in a cross-border raid from Lebanon on Wednesday. Eight Israeli troops were killed in the raid.
Israel is demanding Hezbollah free the soldiers. Hezbollah says they will not be returned without a release deal for Palestinian, Lebanese and other Arab prisoners held in Israeli jails.
A third soldier has been captured by Palestinian militants in the Gaza Strip and Israel is conducting a separate operation there.