His son Manhal, a senior security official, was kidnapped in the same pre-dawn raid by 80 masked gunmen from the Popular Resistance Committees (PRC), some armed with anti-tank grenades, who forced their way into Mr Arafat's home after a 20-minute shoot-out.
The militants dragged the former Palestinian intelligence chief, still wearing his pyjamas, into the street where they shot him. There was no immediate confirmation of Israeli media reports quoting intelligence sources saying Manhal Arafat had also been killed.
Mousa Arafat, 69, was the far-from-popular leader of the Palestinian Military Intelligence Forces, a job he held from his appointment by his cousin in 1994 until his sacking in April by Yasser Arafat's successor, Mahmoud Abbas, as part of a shake-up of the security services urged on him by the international community.
Although the killing of Mr Arafat who the militant leaders claimed had come out shooting with his own weapon is a further sign of lawlessness in the run-up to Israel's scheduled military withdrawal from the Strip next week, the streets of Gaza remained calm after the killing yesterday.
Mr Abbas said there would be a determined hunt for the culprit and stressed that the incident would not disrupt his mission to impose law and order on Gaza.
Mr Abbas cancelled his planned trip to New York for the UN General Assembly to remain in Gaza during the Israeli military withdrawal.
A PRC spokesman, Mohammed Abdel Al, called Mr Arafat a "collaborator" and "corrupt", and said he had been brought onto the street for summary execution so the "world would see he was being liquidated not by mistake but deliberately".
The PRC is mainly composed of renegade Fatah members but is also thought to include members of Hamas and Islamic Jihad.
Sami Abu Zuhri, a Hamas spokesman, said: "He is one of those who hurt the Palestinian people by intimidation, oppression and torture." But he added: "We do not believe in violence in settling accounts."
Egyptian intelligence officials in Gaza reportedly met PRC members to try to secure the release of Manhal Arafat as Nasser Yusef, the Minister of the Interior, put security forces on full alert.
In a bizarre twist late last night, a statement was issued in the name of the PRC denying responsibility for the killing.
Abdallah al-Ifranji, an aide to Mr Abbas, said: "This is a very regrettable and dangerous incident that does not bode well as we await Israel's pullout. The president, cabinet and all security forces are determined to find the perpetrators."
Meanwhile, the Israel Defence Forces Chief of Staff, Dan Halutz, has promised an investigation into the killing of five Palestinians in the West Bank town of Tulkarum last month. At the time, the IDF announced that five members of a "terror network" behind suicide bombings had been killed. But an investigation by the Haaretz newspaper and the Israeli human rights group B'Tselem indicated that the three teenage boys did not belong to a terrorist organisation and the two adults were low-ranking operatives who were unarmed.