Rockets slammed into northern Israel from Lebanon on Thursday, with Hezbollah indicating it was not responsible for the attack that sowed panic on both sides of the tense border.
No group had claimed responsibility for the salvo, which came as Israel pushed on with its 13-day-old offensive on Hamas in the Gaza Strip.
"Three rockets landed in Israel fired from Lebanon," said Israeli police spokesman Micky Rosenfeld, adding that two people were slightly wounded in the area around the northern town of Nahariya.
"We carried out direct fire at the source of the rocket fire from Lebanon," an Israeli army spokeswoman said.
A Lebanese army spokesman said: "Between two and three rockets were fired from southern Lebanon. Israel has retaliated with five or six rockets."
Israeli Defence Minister Ehud Barak said while visiting an army base in the south that "we are following events in the north, we are alert and will know how to respond", his office quoted him as saying.
The exchange echoed the 2006 war between Israel and Hezbollah - which began against the backdrop of Israel's last major offensive in Gaza - and sent Israelis into bomb shelters and Lebanese into cars to flee their homes.
Sirens sounded over northern Israel and residents were directed to bomb shelters, while in southern Lebanon people rushed from the border.
"The residents are starting to flee. There is panic in the area," said resident Fathi Badawi.
United Nations troops deployed in the south of Lebanon also went on alert and the Lebanese government called for an inquiry into who had fired across the frontier into Israel.
Hezbollah assured the Lebanese government it was not responsible for the rocket fire, Information Minister Tarek Mitri said.
"Hezbollah has assured us that they remain committed to stability and Resolution 1701 and that is a euphemism for saying they are not involved," Mitri said, referring the UN Security Council resolution that brought an end to the devastating 2006 war between Israel and Hezbollah.
"We have absolutely no reason to think that Hezbollah might be involved," Mitri added.
Officials in Lebanon representing the two main Palestinian factions Hamas and Fatah both denied that their movements were behind the firings.
"Hamas is pursuing its combat inside Palestine and our principle is not to use any other Arab soil to respond to the occupation," Hamas spokesman Raafat Morra said in Lebanon.
Munir Makdah, an official with the other main Palestinian group Fatah, said: "I doubt that this is the work of any Palestinian faction, the Palestinians are committed not to use Lebanon as a front and our weapons are under the authority of the Lebanese."
All units of the UN force, known as UNIFIL, were deployed across the zone of responsibility to try to prevent further rocket attacks, said a French military official, who spoke on condition of anonymity.
"UNIFIL is in a state of heightened alert since 8.05 local time this morning," he said.
The rockets fell a day after Hezbollah chief Hassan Nasrallah warned that "all possibilities" were open against Israel amid its deadly offensive in Gaza.
Israel and Hezbollah fought a 34-day war in 2006, after guerrillas from the Lebanese Shi'ite movement seized two Israeli soldiers in a deadly cross-border raid.
The war killed more than 1,200 Lebanese, mostly civilians, and more than 160 Israelis, mostly soldiers. During the conflict, Hezbollah sent more than 4,000 rockets into northern Israel.