Militants from Sinai who sneaked across the Egyptian border on Monday killed an Israeli civilian, triggering a firefight with Israel's army which left two gunmen dead, the military said.
Initial fears that more gunmen were still on the loose were later ruled out by the army following hours of searches, and it said a surviving attacker slipped back into Egypt.
The bloodshed mirrors an attack in August 2011 in which gunmen infiltrated from Sinai and staged a series of ambushes in southern Israel, killing eight.
"We see here a disturbing deterioration in Egyptian control in the Sinai," Israeli Defence Minister Ehud Barak said of Monday's attack just hours after the final round of voting in Egypt's presidential election ended.
"We are waiting for the results of the election. Whoever wins, we expect them to take responsibility for all of Egypt's international commitments, including the peace treaty with Israel and the security arrangements in the Sinai, swiftly putting an end to these attacks."
Israel's military said three gunmen sneaked across the border shortly after dawn and attacked two vehicles taking Israeli construction workers to a site where they are building a vast fence along the frontier.
The militants detonated explosive devices and fired Kalashnikov assault rifles and rocket-propelled grenades (RPGs) on a civilian road in Nahal Lavan, military spokeswoman Avital Leibovich said.
"The RPG didn't hit the cars but what did was the explosive device and the light (rifle) fire. One the vehicles was hit by this fire and turned over into a nearby ditch," killing one of the construction workers, she told reporters.
Defence ministry officials identified the victim as Said Fashafsheh, an Arab Israeli from the northern port city of Haifa.
Troops arrived at the scene "within minutes" and began firing at the gunmen, sparking a massive blast caused by an explosive belt worn by one of the attackers, Leibovich said.
"We identified two bodies of these terrorists at the scene," she said. "A third terrorist ran away, or escaped, back into Egypt."
"We also found that they carried with them camouflage uniforms, flack jackets, helmets, grenades and Kalashnikovs," she added, without identifying the nature of the clothing, but ruling out Egyptian military fatigues.
There was no immediate information on their identity and, asked about involvement of groups from the Hamas-run Gaza Strip, Leibovich said it was a possibility being examined but it was too early to tell.
Hours after the ambush, Israeli warplanes struck a motorcycle in northern Gaza, killing two Islamic Jihad activists.
But military officials said it was not connected to the border ambush.
And Gaza's Hamas prime minister Ismail Haniya insisted no Palestinian group was involved in Monday's attack.
Resistance was focused "inside the Palestinian territories and against the Israeli occupation, and was not moving at this stage outside of the borders of the Palestinian homeland," Haniya told reporters.
The ambush came 48 hours after a Grad rocket fired from Sinai struck near the Negev town of Mitzpe Ramon and a second near Ovda, the site of a small civilian and military airport, some 40 kilometres (25 miles) north of Eilat.
In early April, another two Grad rockets were fired at Eilat, but caused no casualties.
Following the ambush in August last year, Israel doubled the pace of construction of its border fence, which is largely finished except in the northernmost and southernmost sectors of the frontier.
Speaking to senior members of his Likud party, Prime Minister Benjamin Netanyahu said the attack appeared to have targeted work on the barrier, which he described as "a supreme national interest."
"It seems that this attack was aimed at Israeli civilians and carried out in a deliberate manner against our people building our security fence on the Egyptian border," a statement quoted him as saying. "It will not stop us."
Since the overthrow of Egyptian president Hosni Mubarak in February 2011, Sinai has been swept by unrest, stoking deep fears in Israel which shares a 240-kilometre (150-mile) border with the Egyptian peninsula.
Israeli Vice Prime Minister Shaul Mofaz said Sinai would pose "a significant challenge" for Egypt's incoming leadership.
"There is no doubt that the situation in Sinai has become a security problem and the incident today is a new stage in the escalation," he told army radio.
"We must demand more action from the Egyptians in Sinai."
And Udi Shani, defence ministry director-general, vowed his team would complete the border fence "as soon as possible."
"The terrorists' aim was to stop the construction of the fence but our job is to finish it as quickly as possible in order to prevent terrorists from infiltrating into Israeli territory in the future."