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Israeli Prime Minister Ehud Barak said the killings were a "very serious" development for the peace process, adding ominously that Israel "will know what to do."

U.N. Secretary General Kofi Annan, who said the act "complicates the issues we are trying to resolve", deplored the killings.

It was unclear by the afternoon if the killings would jeopardize a planned meeting of Israeli and Palestinian security chiefs to be chaired by the head of the United States Central Intelligence Agency.

The soldiers' bodies could be seen lying on the street after hundreds of enraged Palestinians had mutilated them and dragged them from a Palestinian police station where they were being held, witnesses said.

Palestinian police said they were members of a special plain-clothes undercover unit whom they arrested in order to protect them from the crowd.

An Israeli army spokesman said that the Palestinian police had arrested four soldiers, all of whom were non-combatant reservists who held administrative posts in the military. The fate of the other two remained unclear.

He said they had been driving in a civilian car and were on their way to an Israeli base in the area when they got lost and entered Ramallah, which is under the exclusive control of the Palestinian Authority.

Three days earlier, a Palestinian was burned to death by paramilitary Israeli settlers when they abducted him from his olive orchard, took him to their nearby settlement, bludgeoned him to death with clubs and axes and then set him on fire.

The Islamic Association of Palestine (IAP) quoting sources in Ramallah said the settlers, armed with Uzi submachine guns, abducted Isam Judeh Mustafa Hamed, 47, in early morning hours Monday while he was picking olives in his olive orchard at the village of Um Saffa near Ramalla.

They reportedly forced him into an awaiting car at gunpoint. At 10:00am local time (7:00 am GMT), villagers found his charred and mutilated body dumped at the roadside.

Earlier that same day, marauding settlers, who acted as if they received a green light from Barak's government, carried out the killings, murdering two more Palestinian villagers.

The Palestinian Authority said in a statement later that it "regretted" Thursday's incident, but that it continued to hold Israel responsible for recent violence in the territories, which had shown signs of calming amid intense international diplomacy.

Palestinian security forces declared a state of emergency in the Gaza Strip, throwing a cordon around Palestinian leader Yasser Arafat's offices and other strategic buildings.

Israeli television reported that a third soldier had also been killed, with the fourth seriously injured. The report could not immediately be confirmed.

The violence began when news of the arrests of the Israeli soldiers spread and hundreds of mostly young Palestinians demonstrated outside the police station demanding the soldiers handed over.

When the police refused, the youths charged the station, grabbed the soldiers and began beating and stabbing them.

The crowd inside the police station, according to witnesses, killed the soldiers. Their bodies were then dragged into the street.

Israeli television showed chaotic images of hundreds of youths demonstrating outside the police station, and Palestinian police trying to clear the street.

Palestinian security forces took up strategic positions as rumors spread of a possible Israeli army incursion into the town, which is exclusively controlled by the Palestinian Authority.

The expected incursion did occur, as Israeli helicopter gunships bombarded the city in waves of attacks on Palestinian security and administrative buildings in Ramallah, the West Bank and Gaza City in "response" to the Israeli soldier killings.

Arafat, who was not hurt in the helicopter attacks, said the raid would not deter him.

Responding to Israel's raids, Arafat considered the attacks as "war," his international cooperation minister Nabil Shaath said.

Arafat "realizes it is a war, an Israeli war on our land and our people and we are treating it as such," Shaath told reporters as he accompanied the Palestinian leader on a tour of sites damaged in Gaza during the attacks.

"The Palestinians are strong as was said in the Qur'an. We are not affected by this and we will continue our march to Jerusalem, capital of the independent Palestinian state," he told reporters.

Asked how Palestinians could respond to the attacks, Shaath said: "In terms of military capability we don't have rockets, we don't have airplanes and we don't have tanks.

"It is the Israeli army that has the aggressive attacks, but just by sticking to our country we will make the whole world realize that there is aggression that has to stop."

In Gaza, Hamas said the Palestinian Authority on Thursday released most of its activists being held in jail in the Palestinian territories.

It was not immediately clear how many prisoners were set free, but Hassan Yussif, a Hamas leader in the West Bank, had previously said that 120 of the group's members were in jail, after another batch of releases.

Israel's army chief Shaul Mofaz warned that the release of Hamas prisoners increases the risks of attacks against Israel.

Danny Yatom, Prime Minister Ehud Barak's adviser on political and military affairs, Thursday slammed the releases as a violation of Palestinian leader Yasser Arafat's commitments to Israel and Washington under the self-rule accords.

It is unknown whether Yatom addressed Israel's violations of commitments on the same accords.

In the northern West Bank town of Nablus, some 1,000 members of Hamas demonstrated late Thursday to also call for the release of Hamas member Mahmoud Abu Hannud, one of Israel's most wanted men.

"If you want Israel to swim in blood, release the Hamas prisoners," the demonstrators yelled in front of the prison where Abu Hannud is held in Nablus.

In September, a Palestinian security court sentenced Abu Hannud to 12 years in prison after he fled to a Palestinian-run area during a botched Israeli commando raid on his home.

Abu Hannud, one of the leaders of Ezzedin al-Kassam, the clandestine armed wing of Hamas, is wanted in Israel for a string of attacks that have killed dozens of Israelis.

The killing of Israeli soldiers and subsequent air raids followed more than two weeks of fierce street battles in the Palestinian territories that also spilled over into Israel and has claimed at least 100 lives, most of them Palestinians.

The United States, for its part, has said it will strongly oppose any move to raise the Middle East crisis in the Security Council, the U.S. ambassador to the United Nations, Richard Holbrooke, said Thursday.

He was talking to reporters after the Palestinian observer to the U.N., Nasser Al-Kidwa, requested an emergency meeting to demand an immediate end to the use of force by Israel.

"We will oppose any move to bring it back into the Security Council," Holbrooke said.

To do so, he said, would "undermine the valiant efforts" of U.N. Secretary General Kofi Annan, who has been in the Middle East since Monday trying to persuade Israelis and Palestinians to end the violence.

Al-Kidwa said he hoped the council would adopt a resolution supporting three points.

These were: the immediate cessation of violence and the use of force; the immediate implementation of Council Resolution 1322, passed Saturday; and cooperation with Annan's efforts to defuse the crisis.

Holbrooke recalled that the United States had abstained in the vote on Resolution 1322, describing it as "biased and one-sided and unhelpful to the situation."

"The Security Council has effectively ended, at least temporarily, its potential usefulness," he said.