Palestinian terrorists have raided the Alei Sinai settlement in the northern region of Israel's Gaza Strip, firing at residents.
Two residents - believed to be children - were reported killed and five wounded.
The attackers are holding hostage four members of one family, according to reports.
Israeli security officials are attempting to negotiate with the terrorists but the gunmen are firing from the house.
The terrorists initially wounded three Alei Sinai residents when they attacked the settlement at about 7:30pm.
Witnesses said the terrorists entered the village and then randomly opened fire on residents.
Troops rushed to the area and army helicopters flew over the settlement as a heavy exchange of fire between soldiers and the militant continued, Israeli radio stations said.