Israel has launched air strikes on Gaza after gunmen killed seven Israelis in a series of attacks near the border with Egypt.
Officials said the attackers killed seven Israelis.
In the retaliatory air attacks on Gaza, five gunmen and a child were reported killed.
Earlier squads of gunmen armed with heavy weapons and explosives crossed into southern Israel and attacked buses, cars and an army patrol in one of the boldest attacks on the Jewish state in years.
Israel said the attackers were Palestinians from Gaza who crossed through Egypt's Sinai Peninsula.
The attack stoked concerns that Palestinian militants might be exploiting instability in Egypt.
Within hours, Israeli aircraft bombed Gaza in retaliation, and Gaza medical official Adham Salmia said five gunmen and one child was killed in a strike on a private home.
The attacks on Israelis began at midday and lasted for three hours. They came close together and appeared coordinated.
Israeli security forces said they tracked down some of the assailants and killed seven in a gunbattle. Three of the bodies were booby-trapped. There was no immediate word on whether any of the attackers were captured alive.
Israel said the gunmen started out from Gaza and made their way through Sinai, which borders both Israel and Gaza. Egypt and Hamas denied any involvement.
"The incident underscores the weak Egyptian hold on Sinai and the broadening of the activities of terrorists," Israeli Defence Minister Ehud Barak said in a statement.
"The real source of the terror is in Gaza and we will act against them with full force and determination."
It was the deadliest assault in Israel since a Palestinian gunman entered a religious seminary in Jerusalem in March 2008 and killed eight people.
Security in Sinai has deteriorated sharply since February, when long-time leader Hosni Mubarak was ousted in a popular uprising.
Many Israelis saw Mubarak as a source of stability with shared interests in containing Iran and its radical Islamic proxies in the region, such as Hamas. Mubarak also upheld the decades-old peace treaty with Israel.
Last week, Egypt moved thousands of troops into the Sinai peninsula as part of a major operation against al-Qaida inspired militants who have been increasingly active in Sinai since Mubarak was removed in February.
The militants have taken advantage of the security vacuum caused by the abrupt withdrawal of police forces. Authorities have blamed the militants for brazen attacks on police patrols as well as a string of bombings on a key pipeline carrying natural gas to Israel and Jordan.
The attacks began around midday, when attackers targeted a packed passenger bus driving along a highway about 10 miles north of the Red Sea resort of Eilat, close to the border crossing into Sinai.
Within the space of about an hour, along that same road, the attackers opened fire on one more bus and two civilian vehicles, and an army vehicle rushing to the area drove over an explosive device, the military said in a statement.
Around the same time, an undisclosed number of mortar shells were fired from the Gaza Strip at Israeli soldiers conducting routine maintenance work on the security fence along the Israel-Egypt border, the statement said.
In all, six civilians and one soldier were killed, said Israel's southern military commander, Maj Gen Tal Russo.
Israel Radio said a vehicle had followed the bus, and two to three gunmen got out and opened fire with automatic weapons.
The vehicle carrying the assailants fled the scene, and Israeli security forces took off in pursuit. Two helicopters joined the chase.
TV footage showed the bus pulled over by a red, rocky cliff. Windows and a door of the bus were shattered, and soldiers were patrolling the area on foot. Inside the bus, seats were stained with blood and luggage littered the aisle.
"We heard a shot and saw a window explode. I didn't really understand what was happening at first. After another shot there was chaos in the bus and everyone jumped on everyone else," passenger Idan Kaner told Channel 2 TV.
He said the attack lasted three or four minutes until the bus was able to drive away.
After that, an explosive device was detonated under the vehicle of a military patrol called to the scene, and a private car was also attacked.
Roadblocks were thrown up in the area and entrances and exits to Eilat were sealed. Senior Israeli security officials convened in an emergency session at the defence ministry in Tel Aviv.
The military said a "large number" of assailants were working in multiple squads, but it gave no specifics.
"We are talking about a terror squad that infiltrated into Israel," said Leibovich, the Israeli military spokeswoman. "This is a combined terrorist attack against Israelis."
The driver of the bus said he had seen Egyptian soldiers open fire, but the chief Israeli military spokesman, Brig Gen Yoav Mordechai said he was not aware of any Egyptian military involvement.
In Egypt, a senior security official denied that the attackers crossed into Israel from Sinai or that the buses were fired at from inside Egyptian territory.
"The border is heavily guarded," said a Sinai-based official.
Israeli government spokesman Mark Regev said the attackers came from Gaza.
"This is specific information. This is not an assessment. This is not an estimation. This is very, very precise information that they came out of Gaza. We have no doubt." He would not provide more specific details.
Taher Nunu, a spokesman for the Hamas government in Gaza, denied the militants' complicity.
"Gaza has nothing to do with these attacks in Eilat," Nunu said.
In November, Israel began erecting a fence along the porous border with Egypt, in part to keep out Islamic militants operating in Sinai. The fence, which is to take up to two years to build, is expected to cover at least 87 miles of the 150-mile boundary.
The attacks by a team of apparently co-ordinated squads also highlighted the potential for a sharp spike in violence as Palestinians prepare to ask the United Nations to recognise them as an independent state.
Palestinian militants in Hamas-ruled Gaza have fired intermittent barrages of mortar shells into Israel for a decade, even after the Israeli military launched an offensive in the territory in late 2008.
But in recent years Israel has not suffered the repeated deadly suicide bombings and shooting attacks of years past.
Palestinian leaders in the West Bank have drawn up plans for rallies in September in hopes of boosting their drive for UN recognition - an initiative begun after Palestinians lost faith in peace talks with Israel.