SEOUL South Korea said after a rare emergency security meeting on Friday it would respond prudently to the sinking of one of its naval ships by the North, but Pyongyang warned the peninsula was being driven to war.
U.S. Secretary of State Hillary Clinton strongly condemned North Korea's action and called for an international response.
The South announced on Thursday that it had overwhelming evidence a North Korean submarine had entered its waters in March and attacked the Cheonan corvette, killing 46 sailors in what President Lee Myung-bak called a "military provocation."
North Korea denied the accusation and said it was ready to tear up all agreements with the South, with whom it remains technically at war under a truce that ended fighting in the 1950-53 Korean War.
"It was a military provocation and violation of the U.N. Charter and the truce agreement," Lee, whose two years in office have seen relations with the North turn increasingly frosty, said in a statement.
"Since this case is very serious and has a grave importance, we cannot afford to have a slightest mistake and will be very prudent in all response measures we take," his office quoted him as telling a rare emergency National Security Council meeting.
Lee is expected to announce his response early next week.
CLEAR MESSAGE, INTERNATIONAL RESPONSE
Clinton, speaking in Tokyo after talks with Japan's foreign minister, said there must be a clear message to North Korea that provocative actions have consequences.
"We cannot allow this attack on South Korea to go unanswered by the international community," Clinton said after talks with Japanese Foreign Minister Katsuya Okada.
Clinton did not say what international action she wanted to see. Steps could range from fresh U.N. Security Council sanctions on North Korea, although those might be opposed by China, to a statement of condemnation by the world body.
South Korean Defense Minister Kim Tae-young said Seoul would work with the international community to come up with non-military sanctions against the reclusive state.
In the past, both sides had put a limit on their hostility.
"North Korea has surpassed these limits. For those acts, the government will definitely make sure North Korea pays," Kim said.
Yonhap news agency reported South Korea and the United States were considering raising the alert status on North Korea as tensions build.
A senior U.S. official with Clinton told reporters the United States has already increased the vigilance of its military forces in the region.
"PHASE OF WAR"
North Korea was typically defiant.
"From this time on, we will regard the situation as a phase of war and will be responding resolutely to all problems in North-South relations," the North's Committee for the Peaceful Reunification of the Fatherland said in a statement.
"If the South puppet group comes out with 'response' and 'retaliation', we will respond strongly with ruthless punishment including the total shutdown of North-South ties, abrogation of the North-South agreement on non-aggression and abolition of all North-South cooperation projects."
Seoul has repeatedly said it would not strike back at the North, aware that would frighten away investors already jittery about the escalating tension on the divided peninsula.
Apart from international sanctions, there is little else it can do. Economic relations have come to a near standstill since Lee became president, apart from a joint factory park just inside impoverished North Korea which now has to rely almost entirely on China, its only major ally.
Yonhap News cited government sources saying Seoul may shut down sea routes that allow North Korean vessels sail through South Korean waters near its southern end and save costs.
North Korea has often threatened to attack Seoul but most analysts say that, in the face of a much better equipped South Korean army backed by some 28,000 U.S. troops on the peninsula, any major confrontation would be suicidal for Pyongyang.
Some analysts still warned the more the North's now frail leader Kim Jong-il is pushed into a corner, the greater the risk of clashes. Kim is also trying to secure the succession for one of his sons.
China has so far maintained its support of the North and said it would make its own assessment of the investigation into the sinking of the Cheonan.
U.S. officials said they were confident South Korea would seek measured actions and that they saw no signs that North Korea, known for its bellicose rhetoric, was bracing for war.
"The South Koreans do not wish to go to war and they will not take steps that run that risk," said a second U.S. official traveling with Clinton, who will meet top Chinese officials in Beijing on Monday and Tuesday, including President Hu Jintao.
U.S. officials made clear they would try to enlist China's help in deterring North Korea.
"We'd like to see them acknowledge the reality of what happened and then join with South Korea, Japan and us in helping to fashion a response that helps to change the North Korean behavior," said this official.
North Korea's foreign ministry accused Washington of using the Cheonan sinking "to totally break off the Korean peninsula denuclearization process" -- a reference to long-stalled talks to persuade Pyongyang to abandon its nuclear ambitions.
(Additional reporting by Jonathan Thatcher in SEOUL; Isabel Reynolds in Tokyo; Arshad Mohammed in TOKYO and SHANGHAI; and Paul Eckert in WASHINGTON; Editing by Reed Stevenson)