Hezbollah guerrillas killed seven Israeli soldiers and captured two more Wednesday, prompting Israeli airstrikes and military raids inside southern Lebanon, Israeli officials said.
Hezbollah leader Sheik Hassan Nasrallah told reporters that "direct negotiations" would be the only way to return the soldiers and their capture was "our natural, only and logical right."
He demanded the soldiers be swapped for "our prisoners" held by Israel. A demand for Israel to release Palestinians from its jails has been made by Palestinian militants who captured another Israeli soldier, Cpl. Gilad Shalit, last month.
Nasrallah said the two soldiers taken Wednesday had been moved to "a faraway place." Israel has repeatedly refused to consider any swap for its jailed Palestinians.
Israeli Prime Minister Ehud Olmert said the Hezbollah attacks were an "act of war" and blamed the Lebanese government, which he said would be held responsible.
He promised a "very painful and far-reaching" response, The Associated Press reported.
There have been only sporadic border clashes since Israel withdrew its forces from southern Lebanon in 2000 after 22 years of occupation.
Three of the seven soldiers who were killed Wednesday died during fighting with Hezbollah along the Israeli-Lebanese border, and four were killed later as Israeli troops moved into southern Lebanon, said Israel Defense Forces.
In a claim broadcast on Hezbollah's television channel, Hezbollah said it had "destroyed" an Israeli tank crossing into the region.
The valleys along the Israeli-Lebanese border thundered with artillery fire and clouds of blue-gray smoke could be seen rising above Lebanese positions.
Israeli forces, observers said, were bombing roads, bridges and guerrilla positions in southern Lebanon in an attempt to prevent guerrillas from moving the troops deeper into Lebanon.
Israeli forces are also responding to rocket attacks fired by Hezbollah into northern Israel, according to the army.
Israeli military sources confirmed a troop buildup on the northern border and said preparations were being made for possible call-up of reserve soldiers.
"This morning there was an attack on civilians and soldiers in the north. At this moment there are Israeli security forces operating inside Lebanon," Olmert told reporters.
"The government will convene this evening for a special Cabinet meeting. I want to make clear that the events this morning are not a terror attack but an operation of a sovereign state without any reason or provocation."
The Israeli Cabinet is scheduled to meet at 7 p.m. (noon ET), according to Olmert's office.
"The Lebanese government, which Hezbollah is part of, is trying to undermine the stability of the region, and the Lebanese government will be responsible for the consequences," Olmert said.
'We will turn Lebanon's clock back 20 years'
Responding to the most recent incident along the Israel-Lebanon border, Israeli Defense Minister Amir Peretz said in a statement: "The State of Israel sees itself free to use all measures that it finds it needs, and the [Israeli Forces] have been given orders in that direction."
Israel Defense Forces Chief of Staff Dan Halutz told Israeli Channel 10, "If the soldiers are not returned we will turn Lebanon's clock back 20 years."
Four Israeli civilians and six soldiers have been wounded in the fighting so far, according to the Israeli military.
The IDF instructed citizens in northern villages to take shelter as the violence escalated.
It is the latest skirmish between Israel and Hezbollah in Lebanon, whose forces traded cross-border fire in late May following the assassination of an Islamic Jihad official in the southern Lebanese city of Sidon.
Mahmoud Majzoub, also known as Abu Hamza, was killed in a car bombing, which Islamic Jihad blamed on Israel. Israel denied any involvement in the incident.
Hezbollah is designated a terrorist group by the United States and Israel but is a significant player in Lebanon's fractious politics.
Israel set up a security buffer zone in southern Lebanon from 1978 until 2000.