Two of the victims were children, hit by bullets as they played inside their home, while one Palestinian was killed when a bomb he was planting exploded.

Defence Minister Shaul Mofaz said that no time limit had been set for "Operation Rainbow" that was designed to smash tunnels used to smuggle in weapons from under the border with Egypt.

Palestinian leader Yasser Arafat riposted by accusing Israel of carrying out a pre-planned "large massacre", while US President George W. Bush said he was troubled by the violence.

Most of the fatalities were members of the three main Palestinian armed factions -- Hamas, Islamic Jihad and the Al-Aqsa Martyrs Brigades.

But two of the victims were named as 11-year-old Ahmed Mohammed al-Mughayer and his sister Asmaa, 15, who were hit in the head by Israeli bullets as they played in the family's home, witnesses and medical sources said.

A majority of those killed were shot dead by Israeli troops in the Tel al-Sultan neighbourhood of the camp where marksmen had taken up position on rooftops.

Some bodies were only recovered later when the Israeli authorities finally authorised ambulances into the zone.

Another eight were killed in two separate air strikes while one militant died while trying to plant a bomb, which apparently malfunctioned.

The town's Bilal mosque was partially damaged in one of the air strikes, and witnesses and the army said three houses had been bulldozed.

Army chief of staff General Moshe Yaalon justified the demolitions by claiming the houses were being used for weapons smuggling.

"We are not demolishing houses either systematically or proactively," he told reporters. "We took pains before the operation and are taking pains now as well so that the civilians receive everything they need."

The streets of Rafah were largely deserted after the Israelis warned residents by loudspeaker not to leave their homes, but the sound of gunfire could be heard constantly and helicopters swept over at low level.

Locals said troops were conducting searches of houses throughout Tel al-Sultan.

The army had earlier completely sealed off Rafah, closing the link road with the rest of Gaza and the border with Egypt and placing its tanks on the outskirts.

"This operation, which is aimed at ending once and for all the smuggling of arms through the tunnels around Rafah, will continue until our mission is accomplished," a senior officer told AFP, on condition of anonymity.

Mofaz said the operation would "last for as long as it takes."

Hamas' armed wing, the Ezzedine al-Qassam Brigades, issued a statement saying it was ready for a fight to the death.

"Al-Qassam Brigades and all the resistance groups are determined to fight until the last drop of blood and until the last bullet," it said.

Arafat appealed for international intervention to bring the Israeli operation to a halt and called for an emergency meeting of the UN Security Council.

"What is happening in Rafah is a large massacre which has been planned, and they (the Israelis) are saying it will continue," Arafat told reporters at his West Bank headquarters in Ramallah.

"The murders, the destructions and the (population) transfers cannot be tolerated by the Palestinians or by the international community."

Israel's resolve to crack down on Rafah has been stiffened by the death of 13 of its troops at the hands of militant groups in Gaza last week.