One of the gunmen, standing on top of an elevator between the building's lower floors, ambushed troops who pried open doors to the elevator shaft above, on the fifth floor. The shots killed an Israeli naval commando; soldiers returned fire, killing the gunman.
Israel's Haaretz newspaper identified the dead Palestinian as a senior Hamas bomb-maker.
The army fired rockets at the seven-story building, collapsing the walls and ceilings of several floors, a security official said. Believing other militants might have remained hiding on top floors, troops blew up the building, which residents had evacuated. The building housed 15 apartments.
The target of the raid was Mohammed Hanbali, leader of the military wing of the Islamic Hamas militant group in the city, and the army was checking whether he was the dead Palestinian. The army brought Hanbali's father to see the body, but he couldn't make an identification because the dead man was badly disfigured.
The raid came a day after Palestinian Prime Minister Mahmoud Abbas, weakened by a power struggle with Yasser Arafat, told parliament it must either back him or strip him of his post.
Legislators will meet twice in coming days to decide whether to hold a confidence vote that could topple the unpopular Abbas and deliver a major blow to an already troubled U.S.-backed peace plan.
In the Nablus raid, troops surrounded the apartment building and ordered all residents to leave, said Dr. Ziyad Atebeh, who lives nearby.
Soldiers searching the building with dogs came under fire on the fifth floor and gunmen inside the building also hurled hand grenades at the troops, said Maj. Sharon Feingold, an army spokeswoman. One soldier was killed and four others were wounded, one of them critically.
Israel has intensified its hunt for militants since a Hamas suicide bombing on a Jerusalem bus last month. A 27-year-old Israeli man wounded in that attack died Friday, bringing the total killed to 22 people.
Israel has said it will not let up until Palestinian security forces start dismantling Hamas, Islamic Jihad and armed groups with ties to Arafat's Fatah movement.
Israeli officials see Abbas as a moderate Palestinian leader who can't deliver, reports CBS News Correspondent Robert Berger.
In his speech to parliament Thursday, Abbas reiterated that he would not use force, only persuasion, in dealing with militants.
Abbas told legislators he must be given full power to carry out reforms required by the "road map" peace plan. If the demand is met, Abbas would have a stronger hand against militants carrying out attacks against Israelis.
Abbas stopped short of seeking a vote of confidence, but said he is leaving his future in parliament's hands.
"You either provide the resources of power and support those things ... or you take it back," he told legislators.
Summing up his first 100 days in office, Abbas only hinted at his conflict with Arafat, saying there were "problems" between his government and the Palestinian leadership.
But he said that "without a legitimate force in the hands of one authority ... we will not advance one step on the political track" — a reference to the road map, which envisions the creation of a Palestinian state by 2005.
Parliament scheduled a closed-door session Saturday and another one for midweek to meet with Abbas and discuss his demands, after which legislators were to decide whether to hold a confidence vote. Several legislators said they hoped to avoid a vote through mediation. If a vote is called, it would likely be held next week.
Israeli analyst Dan Shiftan said Abbas' desire to end terrorism against Israel does not have popular support from Palestinians.
"By all public opinion polls, we have a majority or at least half the Palestinian people who very strongly say that they are for the continued struggle by violent means against Israel, the perpetuation of the war," he said.
Abbas' appeal is the latest chapter in a power struggle that began just after Arafat, under strong international pressure, appointed him in April. The two wrangled over Abbas' Cabinet choices and Arafat has refused to give him complete control over Palestinian security forces.
Abbas would have more sway over militant groups if he fully controlled the armed services, but Arafat doesn't want to give up one of his last concrete sources of power.
In Washington, U.S. State Department spokesman Richard Boucher praised Abbas for pursuing progress on the peace plan and seeking to unify security forces. The Palestinians, Boucher said, "can only get a state by ending terrorism."
The road map requires that the Palestinians dismantle militant groups.