Two members of the armed wing of the governing Palestinian movement Hamas -- which claimed responsibility for Shalit's abduction -- and a policeman were killed earlier in helicopter raids and tank shelling.

Trucks and infantry took over the remains of Dugit, Elei Sinai and Nissanit settlements, razed last year as part of Israel's historic pullout from the impoverished territory that had meant to draw the curtain on a 38-year occupation.

In the south, two Palestinians were killed and five others wounded in an Israeli air strike after ground forces came under fire from at least eight rockets. The army said the raid targeted an "anti-tank cell".

Ground forces and engineers were operating two kilometres (one mile) into the south, on a mission to uncover tunnels and explosives, the army said.

Dozens of Palestinian families, fearing for their lives faced with the ominous sight of approaching Israeli armour, fled their homes at dawn.

Women clutching babies and a few belongings scurried away on foot toward a line of waiting taxis amid the boom of gunfire.

"We woke up and the tanks were right there. There were fighters in our garden. We had to flee to protect the children," said one father, rushing away from a Beit Lahiya neighbourhood with his wife and four children.

Palestinian officials and residents believe Israel is using the soldier's capture as an excuse to try to topple the Hamas government sworn in last March.

Tzahi Hanegbi, chairman of Israel parliament's defence and foreign affairs committee was unable to rule out the possibility of a long-term presence should Palestinian rocket attacks continue, saying "it could also be years".

An unprecedented Hamas rocket attack Tuesday on central Ashkelon smashed into a school, causing extensive damage and leading Israel's security cabinet to order the military to step up its offensive and section off parts of Gaza.

Prime Minister Ehud Olmert himself warned that the attack on Ashkelon would have "far-reaching consequences" to be felt first by Hamas.

Israel has already bombed the Gaza offices of both the Hamas premier and interior minister, arrested a third of the cabinet in the occupied West Bank and raided multiple militant targets in its offensive.

In Washington, US Secretary of State Condoleezza Rice on Wednesday called on Israelis and Palestinians to exercise restraint but said it was "high time" for Hamas to return 19-year-old Gilad Shalit.

UN Secretary General Kofi Annan, terming the situation "dangerous" and potentially "explosive", also urged both sides "to step back from the brink".

The European Union cautioned that the army's operations had delayed efforts to get much-needed funding to the Palestinians, as 1.4 million people living in impoverished Gaza grapple with food shortages as well as fuel and power cuts.

But repeated international calls for restraint have largely fallen on deaf ears in what has become the worst Middle East crisis since Hamas came to power in March and Olmert formally took the helm in May.

Israel has vowed to unleash its full military might on Gaza, while Hamas' armed wing has vowed a "new era of violence" against the Jewish state.

Israel says Shalit is still alive but has flatly ruled out negotiations with militants and promised to strike anyone linked to them, in a thinly-veiled reference to Syria.