Hamas, the militant Islamic group, responded with an ominous vow of retaliation, urging all its cells throughout Gaza and the West Bank to attack. Similar calls in the past have been followed within days - sometimes hours - by suicide bombings in Israel.
The fiercest fighting took place in the Shajaiyeh neighborhood of Gaza City, where dozens of youths stood in the streets watching the battle as gunfire whizzed by. At one point, a gunman picked up a young schoolboy by his backpack and whisked him out of the battle zone.
"There was great resistance by armed cells in a very densely populated area," said Col. Yoel Strick, a division commander in the Gaza Strip. There were no Israeli casualties, he said.
The dead included a senior Hamas activist and the son of a Palestinian leader.
The stepped-up violence was linked by some analysts to Prime Minister Ariel Sharon's proposals for a unilateral pullout from most of Gaza. With many Israelis, including the military's intelligence chief, concerned such a move might be viewed by Palestinians as a sign of weakness, analysts warned that more military action in the territory could lie ahead.
Senior military officers have said privately that they believe there is a need to increase pressure on the Palestinians ahead of any withdrawal.
"That is presumably what we saw today and what we will see more of," said Israeli analyst Yossi Alpher.
The army said it entered the Gaza City neighborhood to search for militants who fired rockets at nearby Jewish settlements. It said the fighting broke out after militants fired missiles at Israeli tanks.
Twelve militants were killed and more than 40 were wounded, Palestinian doctors said. Among the dead were Mohammed Hilles, 18, son of Ahmed Hilles, the top leader of Yasser Arafat's Fatah faction in Gaza, and senior Hamas activist Hani Abu Skhaila.
Hamas said Abu Skhaila had survived two previous Israeli attempts to kill him, including a missile strike on his car in June in which he suffered shrapnel wounds.
Hamas said he had participated in several deadly attacks on Israelis, including a suicide bombing last month that killed four people at a border checkpoint.
In a separate raid in the Rafah refugee camp along the Gaza-Egypt border, Israeli troops killed three Palestinians, including a militant, as they searched for tunnels used for arms smuggling. The forces demolished three houses and razed citrus and olive groves.
The fighting was the deadliest in Gaza since 19 Palestinians were killed in clashes in Khan Younis on Oct. 7, 2002.
Later Wednesday, thousands of people marched in funeral processions for some of the militants. Masked men in military-style uniforms carried bodies on stretchers, while others fired machine guns into the air and called for revenge.
After the fighting died down, four small rockets were fired into Israel, causing no injuries or damage, the army said. Later, militants fired a mortar at a Jewish settlement in Gaza, badly damaging a house and slightly injuring a settler.
Hamas, which has carried out dozens of suicide bombings in Israel during more than three years of fighting, said the rocket attacks were the first in what promised to be a painful reaction to the Israeli incursion.
The group's militant wing issued a statement calling on all its cells to carry out "huge martyrdom operations ... everywhere in Palestine," referring to suicide bombings in the West Bank, Gaza and Israel.
Hamas leader Abdel Aziz Rantisi posted a statement on the group's Web site promising "astounding retaliation."
While Hamas routinely vows retaliation for Israeli attacks, it rarely issues such widespread calls to arms. In the past, such language has often been followed quickly by violence.
Palestinian Prime Minister Ahmed Qureia said the Gaza incursion endangered efforts to revive long-stalled peace talks.
"We believe that these killings must stop immediately if the peace process is to go forward and bring results," Qureia said in Rome after talks with Italian Foreign Minister Franco Frattini.
As part of his unilateral disengagement plan if peace talks fail, Sharon has talked of removing up to 17 of 20 Israeli settlements in Gaza and imposing a temporary boundary in the West Bank. Israel captured the two areas in the 1967 Mideast war.
The Gaza withdrawal plan has raised concerns in Israel that a pullout would be viewed by Palestinians as a reward for violence.
Addressing these concerns, Defense Minister Shaul Mofaz plans to keep troops stationed in the Gush Katif bloc of settlements in Gaza after a withdrawal, the Haaretz newspaper reported Wednesday.
The paper said Mofaz believes Gush Katif could be used to continue to carry out army operations against militants and as a "bargaining chip" in future talks with the Palestinians.
By Ibrahim Barzak