Israel launched air strikes targeting Hamas militants, after the group, which rules the Gaza strip, fired more than 200 rockets into Israel.
That included a barrage of six rockets that targeted Jerusalem, some 100 kilometres away.
It set off air raid sirens throughout Jerusalem, and explosions could be heard in what was believed to be the first time the city had been targeted since a 2014 war.
The fighting comes amid soaring tensions in Jerusalem, and follows days of clashes at the al-Aqsa mosque compound, the third holiest site of Islam and the holiest site of Judaism.
There are conflicting claims over Jerusalem, with rival religious and national narratives of Israelis and Palestinians rooted in the city.
More than 700 Palestinians were hurt in clashes with Israeli security forces in Jerusalem and across the West Bank in 24 hours, including nearly 500 who were treated at hospitals.
The Israeli military said six Israeli civilians were hurt by rocket fire Tuesday morning.
Israeli Prime Minister Benjamin Netanyahu met with security officials and warned that the fighting could drag on, despite calls for calm from the US, Europe and elsewhere.
He said that “terrorist organisations in Gaza have crossed a red line and attacked us with missiles in the outskirts of Jerusalem,” adding “whoever attacks us will pay a heavy price.”
In a statement issued early on Tuesday, Hamas leader Ismail Haniyeh said the rocket attacks would continue until Israel stops “all scenes of terrorism and aggression in Jerusalem and Al-Aqsa mosque.”
In Monday’s unrest, Israeli police fired tear gas, stun grenades and rubber bullets in clashes with stone-throwing Palestinians at the compound.
More than a dozen tear gas canisters and stun grenades landed in the mosque as police and protesters faced off inside the walled compound that surrounds it.
In an apparent attempt to avoid further confrontation, Israeli authorities changed the planned route of a march by ultranationalist Jews through the Muslim Quarter of the Old City.
The marchers were ordered to avoid the area and sent on a different route circumventing the Muslim Quarter on their way to the Western Wall, the holiest site where Jews can pray.
Marked as Jerusalem Day by Israelis, Monday commemorates Israel’s capture of East Jerusalem from Jordan during the Six-Day War in 1967.