North and South Korea are blaming each other for starting one of the most serious border incidents since the end of the Korean War in 1953.
In an exchange of fire that lasted about an hour, dozens of North Korean shells landed on a South Korean island near the border, killing two soldiers and wounding about 50 people.
Seoul raised its alert level to the highest setting short of war after the shells landed on Yeonpyeong Island.
United States President Barack Obama says North Korea is a threat that - as he put it - will need to be dealt with, but he will not speculate on any military action at this stage. Mr Obama will consult South Korean President Lee Myung-bak about the crisis.
The attack was also denounced by Russia, Japan and the European Union.
Pyongyang accused the South of firing first. The South's military said it had conducted exercises, but shelling was directed away from the North.
North Korea is threatening more attacks unless Seoul agrees to change a disputed maritime border. It is vowing to keep up military attacks if South Korea continues to approach its maritime border.
It says the South's actions are driving the peninsula "to the brink of war".
South Korea's Joint Chiefs of Staff said North Korean shells had started falling in the waters off the island of Yeonpyeong at 2.34pm on Tuesday (0534 GMT).
At least 50 landed directly on the island, most of them hitting a South Korean military base. Sixteen South Korean marines and three civilians were wounded.
President Lee Myung-bak has ordered the army to retaliate with missile strikes if there are further provocations.
The BBC reports there have been occasional cross-border incidents since the Korean conflict ended without a peace treaty in 1953, but the latest comes at a time of rising regional tension.
North Korea's reclusive leader, Kim Jong-il, is thought to be ill and trying to ensure the succession of his youngest son.
On Saturday, it emerged that North Korea had also shown off to an American scientist what it claimed was a new uranium enrichment facility.
The move prompted the United States to rule out the resumption of six-party talks on nuclear disarmament, which Pyongyang abandoned two years ago.
South Korea says it is suspending shipments of flood aid to North Korea. Two months ago it promised an $11 million aid package, which included rice, noodles, cement and emergency supplies, after its neighbour was hit by severe floods in August.
The aid was delivered in the name of the Red Cross and other private organisations, but partly financed by Seoul.
The government says 7000 tonnes of cement would be blocked, along with a big supply of medical supplies.
A US aircraft carrier will join a US-South Korean military drill in waters off the west coast of the Korean peninsula, Yonhap news agency said. The nuclear-powered USS George Washington, which carries 75 aircraft and has a crew of 6000, left Yokosuka naval base, south of Tokyo, on Wednesday morning.
The US Seventh Fleet said its departure was scheduled prior to the latest hostilities between North and South Korea.