At least 129 Sri Lankan army soldiers were killed in fierce fighting with Tamil Tiger rebels on Wednesday close to the northern city of Jaffna.
Clashes between Sri Lankan forces and Tamil Tigers have multiplied
The army said it had collected 55 bodies, while Tamil Tiger rebels handed over 74 more to the Red Cross.
The toll is the worst the army has suffered in one day since a 2002 ceasefire called a temporary halt to the country's 23-year civil war.
Fighting between the two sides has increased markedly over the past year.
Army spokesman Brigadier Prasad Samarasinghe told BBC News that 283 soldiers had also been injured in fighting that lasted from dawn to dusk on Wednesday.
One soldier was captured by the rebels, Brig Samarasinghe said.
Later a spokesman for the Red Cross, Sukumar Rockwood, told the BBC Sinhala service that they had handed over 74 bodies received in Kilinochchi from the Tamil Tigers to the army.
The army said that it had killed 200 rebels, although the Tamil Tigers only confirmed losing 22 fighters from their side.
Independent confirmation of rebel casualties is impossible to obtain and both sides in the conflict routinely magnify or minimise casualty figures to their benefit.
The fighting has been close to a strategic causeway linking Jaffna to the mainland.
The city is controlled by the government, but sits in the midst of rebel territory at the northern tip of the island.
Ethirajan Anbarasan of the BBC's Tamil Service says that the Sri Lankan army's apparent attempts to gain more territory seem to have backfired.
He adds that the intensity of the clashes and the high casualty figures indicate the difficulties, after more than 20 years of civil war, of achieving a military solution to the conflict.
A senior Sri Lankan military source described the clash as a setback.
"There is no doubt that the army suffered a bloody nose," the anonymous source told AFP news agency.
"It was a big mistake. There should have been better planning."
The BBC's Dumeetha Luthra says that talks between the two sides planned for later this month are now hanging in the balance.
On Tuesday, Norway's ambassador to Sri Lanka, Hans Brattskar, told the BBC that the rebels had confirmed they were ready to meet the government on 28 and 29 October in Switzerland.
The rebels want an independent homeland
However, he said the Tigers had told him they could reconsider their decision if the situation on the ground deteriorated.
The US state department said it was "deeply concerned" that the violence was harming hopes of peace talks.
"We call on both sides to cease hostilities immediately and foster an environment that is conducive to holding productive discussions in Geneva," spokesman Sean McCormack said in a statement.
Sri Lankan government spokesman Anura Priya Yapa said that talks would be going ahead despite the latest bloodshed.
"There is no change of plans on the talks and the decision (to attend) remains," he told Reuters.
The clashes on Wednesday lasted up to 12 hours, with residents in the town of Jaffna saying they could hear the noise of heavy artillery in the distance.
An army statement said that air force jets pounded rebel positions on Thursday morning, while rebels continued to shell the army's front line.
Both sides maintain they are acting defensively, our correspondent says, and have retained the right to do so despite agreeing to resume discussions.
The conflict has claimed more than 2,000 lives since it flared again last December, and before the 2002 ceasefire more than 60,000 people were killed in two decades of civil war.
The Tamil Tigers are fighting for an independent homeland in the north and east of the country, and claim that ethnic Tamils have suffered decades of discrimination at the hands of Sri Lanka's Sinhalese majority.