Gunmen launched nearly 60 rockets and mortars since Tuesday night, the largest barrage since before an Egyptian-brokered truce went into effect in and around the besieged Palestinian territory in June. The ceasefire expired five days ago.
Hamas vowed to step up its attacks if the Israeli army responded with strikes against the impoverished territory.
Israel "should know that any decision to attack the Gaza Strip will open the gates of hell and we will make you regret your stupidity with tears of blood," the group's armed wing, the Izz al-Din al-Qassam Brigades, said in a statement.
"The increasing stupidity of Israel is forcing us to intensify the rocket fire, and put thousands more Zionists in the line of fire in order to protect the Palestinian people."
Israel in turn warned that it would strike back.
"Our position is clear -- we will answer quiet with quiet," government spokesman Mark Regev told AFP. "But we will answer terrorist attacks with actions to protect our people."
"Israel has demonstrated up until now enormous restraint despite daily rocket barrages on our civilian populations," he said, adding that Hamas has "acted deliberately to torpedo the calm and to undermine the understandings reached through Egypt."
The Israeli security cabinet met for five hours on Wednesday to discuss a response to the fire from Gaza, but Prime Minister Ehud Olmert imposed a black-out on the discussions.
Wednesday's barrage did not cause injuries but sowed panic among Israelis living near the Gaza border less than two months before a snap general election called for February.
'Rocket barrages to avenge killing of Hamas men'
Two of the rockets were longer-range Grads, which struck some 13 kilometers (eight miles) north of Gaza, hitting a house and an amusement park in the city of Ashkelon, Israeli and Palestinian officials said.
Grads are not fired often by Gaza militants, who usually launch home-made projectiles dubbed Qassams, which have a shorter range and are less accurate.
The military wing of Hamas said Wednesday's volley was "to avenge the killing" of three of its members by the Israeli army late on Tuesday.
The army said it had fired at three militants planting explosives near the border fence.
Since the expiry of the Egyptian-mediated truce on Friday, Israel has threatened to launch a major offensive on Gaza and Hamas warned it would retaliate by resuming suicide attacks inside the Jewish state.
In response to the latest rocket fire, Israel said it would keep the territory sealed on Wednesday after initially planning to re-open crossings to allow in aid shipments.
Children in Ashkelon following rocket attack (Photo: AFP)
Aid groups have warned of a deteriorating humanitarian situation in the tiny overcrowded territory, which has been largely cut off from the outside world by Israel since Hamas violently seized power in June 2007.
They have repeatedly appealed to Israel to ease its blockade and allow shipments into Gaza, where most of the 1.5 million population depends on foreign aid.
Mahmud Zahar, a hardline leader of Hamas, said on Tuesday that the group was ready to renew the truce "if Israel respects the conditions of a ceasefire," including lifting the blockade of Gaza and stopping military raids.
Israeli Foreign Minister Tzipi Livni was due to travel to Cairo on Thursday for talks with Egyptian President Hosni Mubarak on a possible renewal of the truce.
Both Israel and Hamas face delicate balancing acts in dealing with the escalation around Gaza, analysts say.
Ahead of February elections, the Israeli leadership is maintaining a tough line in public, but is wary of launching any large-scale offensive for fear it does not score a decisive victory against Hamas, they say.
And Hamas, despite its bellicose public statements, is not interested in an all-out Israeli assault as that could threaten its position in Gaza, they say.