Israel expressed regret Thursday for the deaths of four Palestinian civilians in army shelling -- a bloody incident that jeopardized shaky steps toward reducing tensions in Gaza.

The need for a peace breakthrough got reinforcement from a U.N. report that said Palestinians are suffering from ever-worsening economic deprivation and the threat of malnutrition as a result of two years of Palestinian-Israeli fighting.

Violence continued Thursday. In Rafah, on the Gaza-Egypt border, Israeli soldiers shot and killed a 12-year-old Palestinian boy, Palestinians said. Residents said Israeli forces opened fire after children threw rocks and bottles at Israeli tanks that were tearing down structures.

The Israeli military said soldiers in Rafah found a tunnel used for smuggling arms across the border. The tunnel was in a house, the military statement said, and soldiers blew it up. During the operation, Palestinians fired rifles and threw hand grenades, firebombs and rocks at the soldiers, who returned the fire, the military said.

In the West Bank city of Nablus, Israeli forces entered the Palestinian government headquarters and set off explosives, a witness said. Residents said they heard a huge explosion all over the city, and witnesses said part of the fortress-like three-story building was destroyed, including the office of the governor, Mahmoud Aloul, who was not in the building at the time. No casualties were reported.

Aloul said there were no explosives or other weapons inside. He told The Associated Press the Israeli operation "is proof of the Israeli aggression against the Palestinian Authority and the Palestinians."

Israeli security sources said that troops searching for bombs and other weapons in the city set off explosives in some buildings. The army did not officially comment on the operation.

On Aug. 18, Israel and the Palestinians agreed on a plan to turn security over to the Palestinians in Gaza and the West Bank town of Bethlehem as a test case for the rest of the West Bank. The Bethlehem handover took place two days later, but there has been no movement in Gaza.

At stake is an end to Israeli control of six other Palestinian cities and towns in the West Bank. Israel sent troops in after homicide bombing attacks in Jerusalem in mid-June, tightening restrictions that had already crippled the Palestinian economy. Israel explains that its roadblocks, curfews and travel bans are necessary to keep suicide bombers out of the country.

Talks over implementation of the Gaza part had already stalled before Israeli shells fell on the Bedouin encampment in Gaza.

A mother, her two grown sons and a relative died in the attack early Thursday. Furious Palestinians charged that Israel was trying to sabotage peace efforts, and militants threatened revenge. Israel defended its actions but expressed regret at the same time.

Israeli Defense Minister Binyamin Ben-Eliezer ordered an inquiry. "I'm deeply sorry about what happened, but you have to understand that our forces are involved in a battlefield situation," he said.

In a statement, the Israeli military said soldiers opened fire on suspicious figures crawling toward an Israeli army post. The statement said that an initial investigation showed signs of crawling and a cellular telephone near the post. The statement added, "The Israeli military expresses regret over casualties among innocent civilians."

Palestinians rejected that explanation, saying the Israeli tanks aimed their shells at the last two structures still standing in the Sheik Ajlin encampment, which is near the Jewish settlement of Netzarim.

"This is an unforgivable crime that is aimed at delaying peace efforts," said Palestinian leader Yasser Arafat.

The militant Hamas threatened revenge. "We will retaliate against the criminals, civilian and non-civilian," spokesman Mahmoud Zahar said.

A preliminary report from the United Nations detailed how the conflict is causing severe hardship. A U.N. statement said that 70 percent of the people in Gaza and 55 percent in the West Bank live beneath the poverty line, defined as per capita consumption of $2 a day.

"Aid money has largely shifted from projects intended to build a prosperous Palestinian state. Now it goes to short-term relief for the Palestinian people intended to reduce such things as malnutrition and epidemics," a U.N statement said. The full report is to be issued next week.

Israel says it offers as much humanitarian assistance as the security situation allows.

Ben-Eliezer met Thursday with U.S. State Department official David Satterfield. A statement from Ben-Eliezer's office said they discussed Palestinian terrorism and the need for reforms in Arafat's regime. Satterfield met with Palestinian officials Wednesday.

Meanwhile, the Justice Ministry said Thursday that an Israeli court has indicted an Israeli Arab woman for planning a suicide bomb attack.

Suad Abu Hamad, 25, from Nazareth in Israel's Galilee, was planning twin suicide bombings with a member of Arafat's Fatah movement from Tulkarem, according to the indictment.

That plan was thwarted on Aug. 7, when Israeli troops stormed the group's hide-out in Tulkarem.