At least five people have died when gunmen armed with heavy weapons, guns and explosives launched three attacks in quick succession in southern Israel near the border with Egypt's Sinai Peninsula.
About a dozen more were wounded, officials said.
The rare violence in that part of the country targeted a passenger bus, a military patrol and a private car, officials said.
Channel 10 TV reported a fourth attack by gunmen, but there was no official confirmation or details.
The military said a "large number" of attackers were working in multiple squads.
"We are talking about a terror squad that infiltrated into Israel," said Israeli military spokeswoman Lt Col Avital Leibovich. "This is a combined terrorist attack against Israelis."
The violence near the resort city of Eilat stoked concerns about growing lawlessness in the neighbouring Egyptian Sinai Peninsula following the removal in February of long-time leader, Hosni Mubarak.
"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."
Bedouins in Sinai co-operate with anti-Israel militants in Gaza, just across the border.
The driver of the bus said he had seen Egyptian soldiers open fire, but military spokesman Brig-Gen Yoav Mordechai said he was not aware of any Egyptian military involvement.
Israeli security forces tracked down some of the assailants and fought a gunbattle with them, Mordechai said. The attackers fired mortars and an anti-tank missile.
The military spokesman's office said a roadside bomb was detonated when a military patrol arrived at the scene of the bus attack and drove over the device.
Mordechai said the nature of the attack indicated that it had been well planned.
The military said several attackers had been killed in the shootout.
A doctor at the main hospital in the area said the medical facility had been put on an emergency alert. Israel Radio said roadblocks were thrown up in the area and that entrances and exits to Eilat were sealed.
Senior Israeli defence officials convened in emergency session at the defence ministry in Tel Aviv.
In Egypt, a senior security official denied that the attackers crossed into Israel from the Sinai Peninsula or that the buses were fired at from inside Egyptian territory.
"The border is heavily guarded," said the Sinai-based official.
Israel Radio said a vehicle had followed the first 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 were 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.
"I was talking to someone sitting next to me and we heard gunshots and we immediately bent over and then we realised there were people injured," a young woman riding the bus told Channel 2 TV.