Schools were closed on government orders for holidays to begin early after a suspected Tiger front group threatened on Monday to attack civilian targets before an ambush on a Pakistan embassy convoy in the capital killed seven people and wounded 17.

Pakistan is one of Sri Lanka's biggest arms suppliers.

The suicide attack on the convoy came after Air Force jets killed at least 19 men and women aged around 17-20 in a raid on rebel territory, truce monitors said.

The Liberation Tigers of Tamil Eelam (LTTE) have accused the military of killing 61 schoolgirls in that raid, but the government said it had killed dozens of guerrillas.

"The fighting has been throughout the night. They are attacking us with artillery and mortar fire in Muhumalai," said a military spokesman, referring to a "border" crossing that separates rebel from government territory in the northern Jaffna peninsula.

"A search operation is also going on."

Thousands of residents were still holed up in churches and homes amid an indefinite curfew as troops tried to smoke out rebels who have landed on an islet to the west of Jaffna town. Residents were stockpiling food, and most phone lines are down.

Aid workers estimate around 100,000 people are newly displaced in Sri Lanka's north and east after the worst fighting since a 2002 truce first erupted in the east three weeks ago.

In the capital Colombo, residents feared of more attacks after two blasts in a week and the chilling threat from the suspected Tiger front organisation to start bombing civilians in the majority Sinhalese south.

The Colombo stock market fell 2.4 percent on Monday as investors worried increased attacks could hurt industries like tourism and dent growth prospects for the $23 billion economy.

South Africa's cricket team wants to pull out of a triangular series with Sri Lanka and India and return home, team sources said.

Many foreign and local companies have put investment plans on hold until it becomes clear whether the island is sliding back into a full-scale war that has already killed around 65,000 people since 1983 and displaced hundreds of thousands.

"There are very real risks in Colombo and clients need to be aware of them," said Maria Kuusisto, South Asia Analyst for Control Risks Group in London.

"Our clients have to keep on operating in Colombo and we are not currently advising them to withdraw. The situation is escalating rapidly in the north and east and, therefore, our clients need to be flexible," she added.

UN Secretary-General Kofi Annan was "profoundly concerned" and urged the government and rebels to return to the negotiating table, allow aid agencies free access and let civilians leave contested areas, a spokesman said overnight.