UPDATE 9-Rockets hit near Tel Aviv as Gaza death toll rises
* Two missiles land close to Tel Aviv, shocking residents
* Israeli defence minister says militants will pay for this
* Gaza rocket hits Israeli house, kills three
* Hamas holds funeral for slain top commander, vows revenge
By Nidal al-Mughrabi
GAZA, Nov 15 (Reuters) - Two rockets fired from the Gaza Strip targeted Tel Aviv on Thursday in the first attack on Israel's commercial capital in 20 years, raising the stakes in a showdown between Israel and the Palestinians that is moving towards all-out war.
Earlier, a Hamas rocket killed three Israelis north of the Gaza Strip, drawing the first blood from Israel as the Palestinian death toll rose to 16, five of them children.
Israeli warplanes bombed targets in and around Gaza city for a second day, shaking tall buildings. In a sign of possible escalation, the armed forces spokesman said the military had received the green light to call in up to 30,000 reserve troops.
Plumes of smoke and dust furled into a sky laced with the vapour trails of outgoing rockets over the crowded city, where four young children killed on Wednesday were buried.
Israeli Defence Minister Ehud Barak said Palestinian militants would pay a price for firing the missiles.
The conflict, launched by Israel with the killing of Hamas's military chief, pours oil on the fire of a Middle East already ablaze with two years of revolution and an out-of-control civil war in Syria.
Egypt's new Islamist President Mohamed Mursi, viewed by Hamas as a protector, led a chorus of denunciation of the Israeli strikes by Palestinian allies.
Mursi's prime minister, Hisham Kandil, will visit Gaza on Friday with other Egyptian officials in a show of support for the enclave, an Egyptian cabinet official said. Israel promised that the delegation would come to no harm.
Israel says its attack is in response to escalating missile strikes from Gaza. Israel's bombing has not yet reached the saturation level seen before it last invaded Gaza in 2008, but Israeli officials have said a ground assault is still an option.
Israeli police said three Israelis died when a rocket hit a four-story building in the town of Kiryat Malachi, some 25 km (15 miles) north of Gaza, the first Israeli fatalities of the latest conflict to hit the coastal region.
Air raid sirens sent residents running for shelter in Tel Aviv, a Mediterranean city that has not been hit by a rocket since the 1991 Gulf War. Israeli sources said one rocket landed in the sea, while another missile landed in an uninhabited area of the Tel Aviv suburbs.
The Tel Aviv metropolitan area holds more than 3 million people, more than 40 percent of Israel's population.
"This escalation will exact a price that the other side will have to pay," Barak said in a television broadcast shortly after the strike.
Speaking at the same time in Gaza, Hamas's prime minister, Ismail Haniyeh, urged Egypt to do more to help the Palestinians.
"We call upon the brothers in Egypt to take the measures that will deter this enemy," he said.
After watching powerlessly from the sidelines of the Arab Spring, Israel has been thrust to the centre of a volatile new world in which Islamist Hamas hopes that Mursi and his newly dominant Muslim Brotherhood in Egypt will be its protectors.
"The Israelis must realise that this aggression is unacceptable and would only lead to instability in the region and would negatively and greatly impact the security of the region," Mursi said.
The new conflict will be the biggest test yet of Mursi's commitment to Egypt's 1979 peace treaty with Israel, which the West views as the bedrock of Middle East peace.
The Muslim Brotherhood, which brought Mursi to power in an election after the downfall of autocrat Hosni Mubarak, has called for a "Day of Rage" in Arab capitals on Friday. The Brotherhood is seen as the spiritual mentors of Hamas.
The offensive began on Wednesday when a precision Israeli air strike killed Hamas military mastermind Ahmed Al-Jaabari. Israel then began shelling the enclave from land, air and sea.
At Jaabari's funeral on Thursday, supporters fired guns in the air celebrating news of the Israeli deaths, to chants for Jaabari of "You have won."
His corpse was borne through the streets wrapped in a bloodied white sheet. But senior Hamas figures were not in evidence, wary of Israel's warning they are in its crosshairs.
The Israeli army said 250 targets were hit in Gaza, including more than 130 rocket launchers. It said more than 270 rockets had struck Israel since the start of the operation, with
its Iron Dome interceptor system shooting down more than 105 rockets headed for residential areas.
Expecting days or more of fighting and almost inevitable civilian casualties, Israeli warplanes dropped leaflets in Gaza telling residents to stay away from Hamas and other militants.
The United States condemned Hamas, shunned by the West as an obstacle to peace for its refusal to renounce violence and recognise Israel.
"There is no justification for the violence that Hamas and other terrorist organisations are employing against the people of Israel," said Mark Toner, deputy State Department spokesman.
The U.N. Security Council held an emergency meeting late on Wednesday, but took no action.
In France, Foreign Minister Laurent Fabius said: "It would be a catastrophe if there is an escalation in the region. Israel has the right to security but it won't achieve it through violence. The Palestinians also have the right to a state."
"GATES OF HELL"
Israel's sworn enemy Iran, which supports and arms Hamas, condemned the Israeli offensive as "organised terrorism". Lebanon's Iranian-backed Shi'ite militia Hezbollah, which has its own rockets aimed at the Jewish state, denounced strikes on Gaza as "criminal aggression", but held its fire.
Oil prices rose more than $1 as the crisis grew. Israeli shares and bonds fell, while Israel's currency rose off Wednesday's lows, when the shekel slid more than 1 percent to a two-month low against the dollar.
A second Gaza war has loomed on the horizon for months as waves of Palestinian rocket attacks and Israeli strikes grew increasingly intense and frequent. Israeli Prime Minister Benjamin Netanyahu, favoured in polls to win a Jan. 22 general election, said the Gaza operation could be stepped up.
His cabinet has granted authorisation for the mobilisation of military reserves if required to press the offensive, dubbed "Pillar of Defence" in English and "Pillar of Cloud" in Hebrew after the Israelites' divine sign of deliverance in Exodus.
Hamas has said the killing of its top commander in a precise, death-from-above air strike, would "open the gates of hell" for Israel. It appealed to Egypt to halt the assault.
Israel has been anxious since Mubarak was toppled last year in the Arab Spring revolts that replaced secularist strongmen with elected Islamists in Egypt, Tunisia and Libya, and brought civil war to Israel's other big neighbour Syria.
Cairo recalled its ambassador from Israel on Wednesday. Israel's ambassador left Cairo on what was called a routine home visit and Israel said its embassy would stay open.
Gaza has an estimated 35,000 Palestinian fighters, no match for Israel's F-16 fighter-bombers, Apache helicopter gunships, Merkava tanks and other modern weapons systems in the hands of a conscript force of 175,000, with 450,000 in reserve.