INCHEON, South Korea (Reuters) - North Korea fired scores of artillery shells at a South Korean island on Tuesday, killing two soldiers, in one of the heaviest attacks on its neighbor since the Korean War ended in 1953.

The barrage -- the South fired back and sent a fighter jet to the area -- was close to a disputed maritime border on the west of the divided peninsula and the scene of deadly clashes in the past. South Korea was conducting military drills in the area at the time but said it had not been firing at the North.

The attack came as the reclusive North, and its ally China, presses regional powers to return to negotiations on its nuclear weapons program and revelations at the weekend Pyongyang is fast developing another source of material to make atomic bombs.

It also follows moves by leader Kim Jong-il to make his youngest, but unproven, son his heir apparent, leading some analysts to question whether the bombardment might in part have been an attempt to burnish the ruling family’s image with the military.

“Houses and mountains are on fire and people are evacuating. You can’t see very well because of plumes of smoke,” a witness on the island told YTN Television before the shelling, which lasted about an hour, ended.

YTN said at least 200 North Korean shells hit Yeonpyeong, which lies off the west coast of the divided peninsula near a disputed maritime border. Most landed on a military base there.

Photographs from Yeongyeong island, just 120 km (75 miles) west of Seoul, showed columns of smoke rising from buildings. Two soldiers were killed in the attack, 17 wounded. Three civilians were also hurt.

News of the attack rattled global markets, already unsettled by Ireland’s debt woes and a shift to less risky assets.

Experts say North Korea’s Kim has for decades played a carefully calibrated game of provocation to squeeze concessions from the international community and impress his own military. The risk is that the leadership transition has upset this balance and that events spin out of control.

South Korean President Lee Myung-bak, who has pursued a hard line with the North since taking office nearly three years ago, said a response had to be firm following the attack.

But he made no suggestion the South would retaliate further, suggesting Seoul was taking a measured response to prevent things getting out of hand.

The North has a huge array of artillery pointed at Seoul that could decimate an urban area home to around 25 million people and cause major damage to its trillion dollar economy.

The two Koreas are still technically at war -- the Korean War ended only with a truce -- and tension rose sharply early this year after Seoul accused the North of torpedoing one of its navy vessels, killing 46 sailors.

North Korea said its wealthy neighbor started the fight.

“Despite our repeated warnings, South Korea fired dozens of shells from 1 p.m. ... and we’ve taken strong military action immediately,” its KCNA news agency said in a brief statement.

South Korea said it had been conducting military drills in the area beforehand but had fired west, not north.

The international community was quick to express alarm at the sudden rise in tension in a region that is home to three of the world’s biggest economies -- China, Japan and South Korea.

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A French diplomatic source said the U.N. Security Council would call an emergency meeting in a day or two over North Korea, against which it has imposed heavy economic sanctions for previous nuclear and missile tests.

Russian Foreign Minister Sergei Lavrov called the escalation in tensions a “colossal danger.

China was careful to avoid taking sides, calling on both Koreas to “do more to contribute to peace.

“China hopes that the relevant parties will do more to contribute to peace and stability in the region ... it is imperative now to resume the six-party talks,” a spokesman for the Chinese Foreign Ministry, Hong Lei, told reporters.

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Those talks on North Korea’s nuclear weapons program -- involving the two Koreas, China, Japan, Russia and the United States -- have long been on ice.

But the North has recently been pushing to resume the talks, which previously it has used to win massive aid in return for promises to end its weapons program.

WON TUMBLES

News of the exchange of fire sent the won tumbling in offshore markets with the 1-month won down about four percent at one stage in NDF trading. U.S. 10-year Treasury futures rose and the Japanese yen fell.

The South Korean central bank, after an emergency meeting, said it planned to cooperate with the government to take measures to stabilize markets if necessary. Many traders expect South Korea’s financial markets to fall further when trading opens on Wednesday.

The attack comes just as a U.S. envoy is in Beijing on a tour of the region and is expected to ask China to use its influence over North Korea.

Washington has branded the North a danger to the region and expressed concern Pyongyang would sell nuclear weapons technology to other states. It has said it was ready to return to talks but wants to see more commitment to denuclearization by the North beforehand.

The White House condemned the attack, telling the North to halt its “belligerent action” and saying it was committed to defend the South.

It has about 28,000 troops in South Korea, their combined forces facing an estimated one million North Korean soldiers who make up one of the world’s biggest standing armies.

“UNBELIEVABLE”

“It’s unbelievable,” said Zhu Feng, professor of international relations at Peking University. “Today’s news proves that North Korea, under unprovoked conditions, shot these South Korean islands. It’s reckless provocation. They want to make a big bang and force the negotiations back into their favor. It’s the oldest trick.”

The North depends heavily on China for economic and diplomatic support and Kim Jong-il has visited China twice this year, in part to gain backing for the anointment of his son as heir.

Those ties have become a sore point with Washington after reports that North Korea appears to have made big steps toward enriching uranium, possibly using technology that passed through or even originated in China.

China has urged returning to the nuclear disarmament negotiations but has also fended off calls from Washington and its regional allies to use its vital food and energy aid to North Korea as a lever.