Israel struck at the heart of the Palestinian government, hitting the Gaza office of the Hamas prime minister in a new wave of air raids and warning it would use all its power to free a soldier captured by militants a week ago.

An Israeli tank points its gun towards Gaza from Nizmit hill at the border of Gaza strip early July 3, 2006. Israeli aircraft blasted the Palestinian prime minister's office early Sunday during the fifth straight night of airstrikes aimed at winning the freedom of an Israeli soldier held captive by Hamas militants in Gaza. [Reuters]

The armed wing of Hamas threatened to retaliate by resuming attacks inside Israel, predicting the region would sink in a "sea of blood" if the Israeli offensive continued.

"The Ezzedine al-Qassam Brigades warn the Zionist enemy: if its operations continue, we will hit the occupation targets we were previously reluctant to strike," said a statement received by AFP in Gaza City.

Israeli Prime Minister Ehud Olmert vowed his government would not bow to "blackmail" as Palestinians cautioned that Egyptian-led mediation efforts under way to free the captured 19-year-old corporal, Gilad Shalit, were faltering.

"Efforts continue but so far in vain. We are near an impasse," Palestinian leader Mahmud Abbas's spokesman Nabil Abu Rudeina told reporters.

Israel has launched its biggest military operation in a year over the captured soldier, sending troops back into the Gaza Strip last week and launching wave after wave of air raids after nightfall.

And in a dramatic new warning to the embattled Palestinian administration, helicopter gunships fired on the office in Gaza overnight of Hamas premier Ismail Haniya, setting the building ablaze.

"It's an attack against a Palestinian symbol," said Haniya, who was not in the office at the time.

"We ask the international community and the Arab League to take its responsibilities towards our people and intervene" to end what he called Israel's "insane policy."

Abbas, inspecting the damage done to the prime minister's office, lashed out at Israel.

"Destroying institutions for the Palestinian people, targeting a power plant or the office of prime minister Haniya are truly criminal operations," he said of Israel's five-day aerial campaign against Gaza.

Israeli Deputy Prime Minister Shimon Peres insisted the raid on Haniya's office was a shot across the government's bows rather than an assassination bid.

"It was not an attempt on his life, but it was a clear warning to stop this double behaviour," Peres told CNN.

Palestinian chief negotiator Saeb Erakat warned that the Israeli air strikes were only escalating the crisis.

"I don't want to sound pessimistic, but I'm really afraid that every hour that passes ... we're going to lose the ability to solve the crisis, diplomatically and politically," he told CNN.

And UN Secretary General Kofi Annan expressed concern that the Israeli onslaught could undermine the possibilities for a lasting settlement of the Middle East conflict.

"I remain very concerned about the need to preserve Palestinian institutions and infrastructure - they will be the basis for an eventual two-state solution and that's in the interest of both Israel and the Palestinians," the UN chief said.

"It would therefore seem inadvisable to carry out action that will have the opposite effect."

Israel has rejected outright the demands of militant groups which seized Shalit in a deadly attack on an army post on the Gaza border on June 25 and are now seeking the release of Palestinian prisoners.

It has also threatened to strike at Hamas leaders, including those based in Damascus, raising fears of a regional escalation of the worst crisis in the Middle East since Hamas came to power and Olmert took the helm in Israel.

"My government has instructed the IDF (army) and the security establishment to do everything in order to bring Gilad back home... and when I say everything, I mean everything," Olmert told the weekly cabinet meeting.

Olmert called on Damascus to expel militant leaders, including Hamas leader Khaled Meshaal, in a telephone conversation with US Secretary of State Condoleezza Rice.

"The key to resolving the crisis is in Damascus since the directives and orders for terrorist actions originate there," Olmert said.

"The Syrian leadership must dismantle the terrorist organization command centres located in its territory," he added, according to his office.

In a clear message to Syrian President Bashar al-Assad last week, four Israeli warplanes overflew one of his palaces in northern Syria while he was in residence.

The international community has issued urgent appeals for restraint on both sides to ensure the standoff does not spread across the region, while US President George W. Bush said the release of the soldier was "key" to ending the crisis.

An Israeli army spokesman said three more militants were shot dead in the southern Gaza Strip after approaching an army unit near the territory's disused airport. It was not immediately clear to which faction they belonged.

Israel last week hit the Hamas-run interior ministry in Gaza, detained scores of Hamas members in the occupied West Bank including eight ministers and more than 20 lawmakers, and revoked the Jerusalem residency of four others.

Haniya carried out an emergency cabinet reshuffle Sunday to replace the detained ministers.

With the threat of a fullscale Israeli ground offensive looming, already impoverished residents of Gaza, one of the most densely populated areas on the planet with a population of 1.4 million, are grappling with shortages of food, fuel and electricity.

Israel temporarily opened a border crossing to allow in supplies of humanitarian supplies including food, and it resumed pumping fuel.

About 5,000 troops and columns of Israeli tanks are poised on the Gaza border in the largest Israeli military operation since it pulled out of the tiny coastal territory last September, ending a 38-year presence. But it has held off so far from sending in more troops from the north.