It came as Israeli military officials readied a second invasion force for a huge offensive into Gaza.

Hamas's Gaza-based political leaders, including Mr Haniyeh, had already gone into hiding.

But last night's direct threat to kill Mr Haniyeh, a democratically elected head of state, sharply raised the stakes.

The bid to free Corporal Shalit was brokered by Egyptian President Hosni Mubarak, who last night warned Hamas it faced severe consequences if it did not curb its "extreme stance" and described the growing conflict as a lightning rod for Palestinian vengeance.

Jerusalem has made no official comment, but Egyptian state media said Israel had found the offer unacceptable. Israel has not spelt out the terms demanded by Hamas, but earlier this week it refused to buy into talk of a prisoner swap.

Thousands of Hamas supporters protested in Gaza City late on Thursday over the arrest by Israeli forces of up to 32 Hamas MPs on the West Bank that day.

A Hamas spokesman said the group would never recognise Israel, in spite of a deal its leaders signed this week offering implicit recognition of the Jewish state in return for easing an economic blockade.

Israeli fighter jets bombed 20 targets in Gaza, including the Interior Ministry, which it said had been used by militants to stage meetings, while artillery hit the northern strip with 500 shells in the 24 hours until yesterday morning.

Jewish settler Eliyahu Asheri, who was murdered by militants this week, was buried on Thursday as leaders of the Popular Resistance Committees pledged to seize more hostages in the West Bank. No further word has emerged about another suspected Jewish hostage, Noach Moskowitz, who Israeli police said was found dead hours after Mr Asheri's remains were found.

Much of Gaza, including two main hospitals, was without power and running water as a UN aid chief warned that the 1.4 million residents of the strip were three days away from a humanitarian crisis.

"They are heading for the abyss unless they get electricity and fuel restored," said emergency relief co-ordinator Jan Egeland, who urged militants to free Corporal Shalit and stop firing rockets into Israel.

Residents complain that sonic booms caused by Israeli jets traumatise children and that shelling confines families to their homes.

Israeli Prime Minister Ehud Olmert has vowed the military will do all it can to avoid civilian deaths if a full-scale assault is launched.

Mr Olmert said the decision to invade northern Gaza had already been delayed to allow Mr Mubarak's negotiations to continue.

The arrested Hamas legislators have been sent to security prisons and many will stand trial on terrorism offences. The detentions have hurt Hamas's already limited ability to govern and are likely to force a regime change.

Israel claims it has intelligence about the area where Corporal Shalit is held, but has been unable to pinpoint the exact location. Mr Olmert said the military would leave the strip if he was unconditionally and safely returned.

Egypt and the neighbouring Arab states of Jordan and Lebanon fear a war between Israel and the Palestinians could lead to uprisings within their own borders, which house many Palestinian refugees.