North Korea fired hundreds of artillery shells at a South Korean island on Tuesday, in one of the heaviest bombardments on the South since the Korean War ended in 1953. South Korea responded by firing 80 rounds of shells back at the North.

South Korea's military said two soldiers were killed in the attack, and another 17 troops and at least three civilians wounded.

The skirmish began when Pyongyang warned the South to halt military drills in the area, according to South Korean officials. When Seoul refused, the North bombarded the small South Korean-held island of Yeonpyeong, which houses military installations and a small civilian population.

South Korea returned fire and dispatched fighter jets in response, and said there could be considerable North Korean casualties as troops unleashed intense retaliatory fire.

The supreme military command in Pyongyang threatened more strikes if the South crossed their maritime border by even 0.001 millimeter, according to the North's official Korean Central News Agency.

South Korean President Lee Myung-bak, who has pursued a hard line with the reclusive North since taking office nearly three years ago, said a response had to be firm following the attack on Yeonpyeong island, just 120 km (75 miles) west of the capital Seoul.

North Korea blamed South Korea for initiating the fire, prompting it to take military action.

"Despite our repeated warnings, South Korea fired dozens of shells from 1 p.m. ... and we've taken strong military action immediately," the North's official KCNA news agency said in a brief statement.

The two Koreas are still technically at war - the Korean War ended only with a truce -and tension rose sharply early this year after Seoul accused the North of torpedoing one of its navy vessels, killing 46 sailors.

Witnesses said at least 60 or 70 houses were struck in the shelling. "Houses and mountains are on fire and people are evacuating. You can't see very well because of plumes of smoke," a witness on the island told YTN Television.

YTN said at least 200 North Korean shells hit Yeonpyeong, which lies off the west coast of the divided peninsula near a disputed maritime border. Most of the shells landed on a South Korean military base there.

The shelling lasted for about an hour and then stopped abruptly.

YTN showed pictures of plumes of smoke pouring from the island and quoted a witness as saying fires were burning out of control. It said many of the shells had landed on a military base on the island, about 3 km (1.8 miles) south of the disputed sea border.

News of the exchange of fire sent the won tumbling in offshore markets with the 1-month won down about four percent in NDF trading. U.S. 10-year Treasury futures <TYc1> rose and the Japanese yen fell.

The South Korean central bank said it would hold an emergency meeting to assess the possible market impact of the shelling.

The attack comes just as a U.S. envoy is traveling to the region after revelations that the North is moving ahead with uranium enrichment, a possible second path to manufacture material for atomic weapons.

North Korea has said it wants to restart six-party nuclear disarmament talks it abandoned two years ago. But Seoul and Washington have said the North must move forward with previous pledges to curtail its nuclear program.

"It's unbelievable," said Zhu Feng, professor of international relations at Peking University. "Today's news proves that North Korea, under unprovoked conditions, shot these South Korean islands. It's reckless provocation. They want to make a big bang and force the negotiations back into their favor. It's the oldest trick."

A U.S. academic, Siegfried Hecker, who recently visited North Korea, said at the weekend that he had seen more than a thousand centrifuges for enriching uranium during a tour of the North's Yongbyon nuclear complex.

The White House condemned the attacks and demanded that North American "halt its belligerent action."

"The United States is firmly committed to the defense of our ally, the Republic of Korea, and to the maintenance of regional peace and stability," the White House said, adding that it was in close and continuing contact with South Korea over the situation.

A U.S. official, speaking on anonymity, told Reuters that U.S. forces in Korea were closely monitoring the situation. But no U.S. troops were involved in the response to the North's artillery fire, the official said.

There are around 28,000 U.S. forces stationed in South Korea.

China, the closest the isolated state of North Korea has to an ally, also expressed concern about the incident.

The impoverished North depends heavily on China for economic and diplomatic support and its leader, Kim Jong-il, has visited China twice this year, in part to gain backing for the anointment of his son to eventually take over the family dynasty.

Those ties have become a sore-point with Washington after reports that North Korea appears to have made big steps toward enriching uranium, possibly using technology that passed through or even originated in China.

China has urged returning to the nuclear disarmament negotiations but has also fended off calls from the U.S. and its regional allies to use its vital food and energy aid to North Korea as a lever.

Meanwhile, the UN Security Council was planning to meet in the coming days to discuss the skirmishes.