Militants armed with guns and grenades fired on a group of Jewish settlers who were walking along a main road near the Tomb of the Patriarchs, a site revered by both Jews and Muslims.
The Israeli army described the attack as a carefully planned double ambush, with gunmen attacking first the settlers and then troops who tried to come to their rescue.
Hours after the attack, Israeli helicopter gunships fired missiles into Gaza City, destroying a metal workshop. There are reports that two men - one of them a Palestinian policeman - were wounded by shrapnel.
A Foreign Ministry spokesman ruled out talks with the Palestinians following the Hebron killings.
"No political process can take root while these atrocities continue to be carried out by Palestinian terrorists," Gilad Millo told AFP news agency.
Attackers killed
Prolonged gun battles raged, making it difficult to reach the wounded.
"There was gunfire from left and right, from every possible angle, they were shooting at us from above," a witness who gave his name only as Arik, told army radio. "The group of Jews were slaughtered."
It is not yet known how many of those killed were settlers.
Israeli army radio said troops had killed a number of the attackers.
The militant Palestinian group Islamic Jihad said it carried out the shooting, the worst such incident in Hebron since the start of the intifada - or uprising - more than two years ago.
Dozens of the group's supporters gathered in a Gaza City refugee camp to celebrate the attack, which was described as a "gift to every martyr".
The attack comes just days after a Palestinian gunman killed five people at an Israeli kibbutz and correspondents say it is bound to increase pressure on Prime Minister Ariel Sharon to respond decisively.
The Israeli security cabinet is expected to meet to agree a response.
'Senseless violence'
United Nations Secretary General Kofi Annan condemned what he described as "the despicable terrorist attack".
"The secretary general reiterates his appeal to all Palestinian groups to stop all such acts of senseless violence, which are extremely harmful to the Palestinian cause," his spokesman Hua Jiang said.
In another incident, Israeli forces shot dead a Palestinian activist during a raid in the West Bank town of Jenin.
Palestinian radio said Mahmud Abbas Ubayd was killed as tanks and military vehicles entered Jenin.
Israeli army sources said he was a member of Yasser Arafat's Fatah group.
Troublespot
Flares lit up the night sky and military helicopters helped evacuate the wounded in Hebron, including the regional brigade commander, the Associated Press said.
Senior Israeli defence officials had urgent discussions after the attack and senior officers went to Hebron to oversee the military deployment at the scene, the Israeli newspaper Ha'aretz reported.
A spokesman for Islamic Jihad told Al-Jazeera television the attack was in retaliation for Israel's killing of one of its members, Iyad Sawalha, last Saturday.
One of Israel's most wanted men, 32-year-old Sawalha was blamed by the security services for two suicide bomb attacks which killed 31 Israelis and injured scores others.
The road where Friday's attack took place is used by devout Jews walking between the nearby settlement of Kiryat Arba and Hebron to pray at the Tomb of the Patriarchs.
About 450 Jewish settlers, many of them armed, live alongside 130,000 Palestinians in Hebron, which was divided into Israeli and Palestinian-controlled sectors under an interim peace deal in 1997.
The city has frequently been the scene of violent clashes between the two sides because of its religious significance.
Last month, Israeli forces staged a limited pull-back from re-occupied areas of Hebron, but this is now likely to be reversed.