Four Israeli soldiers have been killed and eight wounded after Palestinian militants blew up explosives in a tunnel near an Israeli army post on the Gaza-Egypt border.
A second huge explosion rocked the border area barely an hour afterwards.
The armed wing of the Palestinian Islamist movement Hamas and the Fatah Hawks, an armed group linked to the mainstream Fatah movement, claimed responsibility for the attacks on what it called an Israeli military post.
Separately, the jailed Palestinian leader, Marwan Barghouti, has withdrawn from next month's Palestinian elections.
The surprise move, announced by an aide, comes 10 days after he declared himself a candidate to succeed the late Yasser Arafat as Palestinian leader.
Israeli cabinet agrees to free prisoners
Israel's cabinet has agreed to free dozens of Palestinian prisoners in a goodwill gesture ahead of Palestinian elections next year.
The pre-vote concession had been expected in advance of the elections on 9 January.
The move is also being viewed as a boost to the electoral chances of former Prime Minister, Mahmoud Abbas.
It is not clear when the Palestinian prisoners will be freed or who will be on the list.
Meanwhile, coalition peace talks have begun between Israel's opposition Labour party and the Prime Minister, Ariel Sharon.
Labour leader Shimon Peres said that his party want a guarantee that the government fulfils its promise to evacuate all 21 Jewish settlements from the Gaza Strip and that it follows the roadmap peace plan with the Palestinians.
Mr Sharon needs Labour support to help restore his parliamentary majority and avoid early elections.
He invited Labour to begin talks after his right wing Likud party's central committee voted to overturn its earlier ban on negotiating an alliance.
