By Maayan Lubell, Nidal Al-Mughrabi and Ammar Awad

JERUSALEM/GAZA/SDEROT, Oct 7 (Reuters) - Gunmen from the Palestinian group Hamas rampaged through Israeli towns on Saturday, killing at least 250 Israelis and escaping with dozens of hostages in by far the deadliest day of violence in Israel since the Yom Kippur war 50 years ago.

More than 230 Gazans were also killed when Israel responded with one of its most devastating days of retaliatory strikes. Fighting continued into the night.

"We will take mighty vengeance for this wicked day," Prime Minister Benjamin Netanyahu said.

"Hamas launched a cruel and wicked war. We will win this war but the price is too heavy to bear," he said. "Hamas wants to murder us all. This is an enemy that murders mothers and children in their homes, in their beds. An enemy that abducts elderly, children, teenage girls."

Hamas leader Ismail Haniyeh said the assault that had begun in Gaza, a narrow strip that is home to 2.3 million Palestinians, would spread to the West Bank and Jerusalem. Gazans have lived under an Israeli blockade for 16 years.

In a speech, Haniyeh highlighted threats to Jerusalem's Al-Aqsa Mosque, the continuation of the blockade on Gaza and Israeli normalization with countries in the region. "How many times have we warned you that the Palestinian people have been living in refugee camps for 75 years, and you refuse to recognise the rights of our people?"

Bodies of Israeli civilians were strewn across the streets of Sderot in southern Israel, near Gaza, surrounded by broken glass. The bodies of a man and woman were sprawled across the front seats of a car.

"I went out, I saw loads of bodies of terrorists, civilians, cars shot up. A sea of bodies, inside Sderot along the road, other places, loads of bodies," said Shlomi from Sderot.

Terrified Israelis, barricaded into safe rooms, recounted their plight by phone on live television.

Esther Borochov, who fled a dance rave party attacked by the gunmen, told Reuters she survived by playing dead in a car after the driver trying to help her escape was shot point blank.

"I couldn't move my legs," she told Reuters at the hospital. "Soldiers came and took us away to the bushes."

Senior military officers were among those killed in fighting near Gaza, the Israeli military said.

Israeli troops clashed with Hamas fighters throughout the night in some parts of southern Israel. In a briefing on social media, an Israeli army spokesperson said the situation was not fully under control.

The Israeli prime minister's office said the security cabinet had approved steps to destroy the military and governmental capabilities of Hamas and Islamic Jihad "for many years", including cutting electricity and fuel supplies and the entry of goods into Gaza.

In Gaza, black smoke, orange flashes and sparks lit the sky from explosions. Israeli drones could be heard overhead. Earlier, crowds of mourners had carried the bodies of militants through the streets, wrapped in green Hamas flags.

Gaza's dead and wounded were carried into crumbling and overcrowded hospitals with severe shortages of medical supplies and equipment. The health ministry said 232 people had been killed and at least 1,700 wounded.

Streets were deserted apart from ambulances racing to the scenes of air strikes. Israel cut the power, plunging the city into darkness.

BIDEN OFFERS SUPPORT TO NETANYAHU

Western countries, led by the United States, denounced the attack.

At the White House, President Joe Biden went on national television to say Israel had the right to defend itself and issued a blunt warning to Iran and other countries hostile to Israel. "This is not a moment for any party hostile to Israel to exploit these attacks to seek advantage. The world is watching," he said.

A senior Biden administration official told reporters that the United States was working with other governments to make sure the crisis does not spread and is contained to Gaza.

The United States has been trying to strike a deal that would normalize ties between Israel and Saudi Arabia, seen by Israelis as the biggest prize yet in their decades-long quest for Arab recognition. Palestinians fear any such agreement could sell out their dreams of an independent state.

Osama Hamdan, the leader of Hamas in Lebanon, told Reuters that Saturday's operation should make Arab states realize that accepting Israeli security demands would not bring peace.

"For those who want stability and peace in the region, the starting point must be to end the Israeli occupation," he said. "Some (Arab states) unfortunately started imagining that Israel could be the gateway for America to defend their security."

Across the Middle East, there were demonstrations in support of Hamas, with Israeli and U.S. flags set on fire and marchers waving Palestinian flags in Iraq, Lebanon, Syria and Yemen.

The Hamas attack was praised by Iran and by Hezbollah, Iran's Lebanese allies.

Long after nightfall, residents had not been given the all-clear to go home.

"It's not over because the (army) hasn’t said the kibbutz is clear of terrorists," Dani Rahamim told Reuters by telephone from a shelter where he was hiding in Nahal Oz, close to the Gaza fence. Gunfire had subsided but regular explosions could still be heard.

Hamas deputy chief Saleh al-Arouri told Al Jazeera that the group was holding a large number of Israeli captives, including senior officials. He said Hamas had enough captives to make Israel free all Palestinians in its jails.

Hamas, which advocates Israel's destruction, said the attack was driven by what it said were Israel's escalated attacks on Palestinians in the West Bank, Jerusalem and against Palestinians in Israeli prisons.

"This is the day of the greatest battle to end the last occupation on earth," Hamas military commander Mohammad Deif said, announcing the start of the operation in a broadcast on Hamas media and calling on Palestinians everywhere to fight.

Gaza has been devastated by four wars and countless skirmishes between Hamas and Israel since the militants seized control of the strip in 2007. But the scenes of violence inside Israel itself exceeded anything there even at the height of the Palestinian Intifada uprisings of past decades.

That Israel was caught completely off guard was lamented as one of the worst intelligence failures in its history, a shock to a nation that boasts of its intensive infiltration and monitoring of militants.

Scores of Palestinians were killed and hundreds wounded in clashes at Gaza's border into Israel, where fighters captured the crossing point and tore down fences. Some of the dead were civilians, among crowds that attempted to cross into Israel through the damaged gates.

"We are afraid," a Palestinian woman, Amal Abu Daqqa, told Reuters as she left her house in Khan Younis.

The escalation comes against a backdrop of surging violence between Israel and Palestinian militants in the Israeli-occupied West Bank, where a Palestinian authority exercises limited self-rule, opposed by Hamas that wants Israel destroyed.

The West Bank has seen stepped-up Israeli raids, Palestinian street attacks and assaults by Jewish settlers on Palestinian villages. Conditions for Palestinians have worsened under Netanyahu's hard-right government. Peacemaking has been stalled for years.

There were clashes in several locations in the West Bank on Saturday, with stone throwing youths confronting Israeli troops. Four Palestinians including a 13-year-old boy were killed. Palestinian factions called a general strike for Sunday.

Israel itself has been experiencing internal political upheaval, with the most right-wing government in its history attempting to overhaul the judiciary.