North Korea has fired artillery shells across its western maritime border, prompting return fire from South Korea, reports say.
Dozens of the shells landed on a South Korean island, witnesses say.
A television station said some houses on the island were on fire, and Yonhap news agency said that four South Korean soldiers had been hurt.
South Korea has issued its highest non-wartime alert in response to the incident, the defence ministry said.
Top leaders are meeting in an underground bunker in Seoul over the incident, Reuters news agency reported.
The incident comes days after North Korea revealed it had a modern uranium enrichment plant - potentially giving it a second route to a nuclear weapon.
Earlier, the US ruled out more denuclearisation talks while Pyongyang continued to work on the facility.
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"A North Korean artillery unit staged an illegal firing provocation at 1434 PM (0534 GMT) and South Korean troops fired back immediately in self-defence," a defence ministry spokesman told AFP.
A resident on the island told the agency that dozens of houses were damaged, while television pictures reportedly showed plumes of smoke rising above the island.
"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 station.
"People are frightened to death and shelling continues as we speak," the witness said.
South Korea had deployed fighter jets to the island, Yonhap news agency said.
So, there we have it.
Personally, I'm not concerned about an escalation of violence. The two Koreas have had their moments in the past; this one is unlikely to be the straw that breaks the camel's back. It's just more Northern sabre-rattling. Even so, a direct exchange of fire is pretty extreme - even by North Korean standards.
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