The attackers slipped through Israeli security
Seven people were wounded in the attack on the Adora settlement near the city of Hebron.
The shootings came as a UN fact-finding mission was gearing up to visit the region - a day later than initially planned, as an Israeli cabinet decision on the visit is still awaited.
The team is due to investigate the recent Israeli military operation in the Jenin refugee camp, where Palestinians say a massacre took place.
Saturday's raid is the first deadly Palestinian attack on Israelis since a suicide bomber killed six people near a Jerusalem market on 12 April.
An Israeli government spokesman blamed the shooting on a "pyramid of terror" headed by Palestinian leader Yasser Arafat, saying Israel would continue "its fight against terrorism".
The BBC's Jeremy Cooke says the fact that the Israeli chief of staff Shaul Mofaz flew in to take personal charge of the operation to hunt down the gunmen could indicate that the incident may provoke a major Israeli response.
Terror 'not eradicated'
The Israeli army said three attackers dressed in what appeared to be army uniforms entered Adora and started going house to house, entering two of them and shooting through the windows of others.
One of those killed was a woman lying in bed - her husband was injured in the attack.
A five-year-old girl was also killed while hiding under her bed.
After the attack, Israeli soldiers searched Adora and mounted a massive manhunt, killing one of the gunman in the nearby village of Taffuh, Israeli radio said.
Hebron, where about 400 Jewish settlers live under heavy security among 120,000 Palestinians, was the only big West Bank city not reoccupied in Israel's recent military operation.
"The attack this morning against Israeli citizens in the West Bank proves that terror has not yet been eradicated," Israeli government spokesman Aryeh Mekel said.
Israel had declared its offensive aimed at rooting out Palestinian militants over, but briefly re-occupied the town of Qalqilya on Friday, killing a local militant leader and arresting at least 46 men.
Bethlehem siege
In a separate incident, a Palestinian was shot dead near the settlement of Dugit in the northern Gaza Strip.
The French news agency AFP quoted Palestinian medical sources as saying the man in his 20s was shot by Israeli troops as he approached the settlement.
In Bethlehem, a shooting incident was reported as the siege at the Church of the Nativity continued into its 25th day.
Several shots were heard outside the basilica where 200 Palestinians including 30 gunmen are surrounded by Israeli troops.
One person from inside the church was later taken away on a stretcher by Israeli military medical personnel.
Later there was a huge explosion as Israeli soldiers tried to neutralise what they said was a truck full of explosives. No one was hurt.
Jenin delay
Earlier on Saturday, the United Nations Secretary General, Kofi Annan, agreed to a call by Israel to delay the departure of a UN fact-finding mission, which will examine the Israeli military action against Palestinians at the Jenin refugee camp.
The team now aims to set out for the region on Sunday, to arrive after the Israeli cabinet discusses the issue.
Two Irish policemen with counter-terrorist experience have joined the group, to meet Israeli objections that it was dominated by humanitarian rather than military specialists.
But our correspondent says that the Israeli cabinet is split on the issue and is not certain to agree to accept the mission.