Hezbollah leader Hassan Nasrallah has promised "open war" against Israel, in an address broadcast shortly after his Beirut offices were bombed by Israel.
The militant group said its leader was unhurt in the attack. It was not clear when his remarks were recorded.
Israel is demanding Hezbollah free two Israeli soldiers. More than 60 Lebanese have been killed in the offensive.
Meanwhile Israel says four soldiers are missing after a naval ship was damaged by a Hezbollah explosive drone.
It is thought to be the first time Hezbollah has used such a weapon.
The ship has now been towed back to Haifa and a search is continuing for the missing men.
Israel says a Hezbollah rocket aimed at one of its ships early on Saturday missed, and hit a civilian ship instead.
'War on every level'
In his address on Hezbollah's TV channel in Lebanon, Sheikh Nasrallah referred to an Israeli warship he said had launched attacks from of the coast of Lebanon, saying: "Look at the warship that has attacked Beirut, while it burns and sinks before your very eyes."
Israel later confirmed that one of its warships had been "lightly" damaged by rockets fired from the shore.
But later unnamed military officials were reported as saying that the ship's steering had been damaged, that its helicopter deck had been hit and that it was still on fire hours after the attack.
Sheikh Nasrallah threatened Israel, saying: "You wanted an open war and we are ready for an open war."
ISRAEL IN LEBANON
March 1978: Israel invades to stop Palestinian attacks
1982: Full-scale invasion; Israel occupies Beirut; pro-Israel Lebanese militias massacre Palestinian refugees
May 1983: Israel pulls back, but keeps "security zone"
February 1992: Israeli air strike kills Hezbollah leader
1996: Israel launches "Grapes of Wrath" raids on Hezbollah; 100 civilians die under Israeli shelling of UN base at Qana
May 2000: Israel withdraws troops from Lebanon
January 2004: Prisoners-bodies swap agreed between Hezbollah and Israel
The Hezbollah leader promised "war on every level". He said the Israeli coastal city of Haifa would come under attack, "and believe me, even beyond Haifa".
"Our homes will not be the only ones to be destroyed, our children will not be the only ones to die," he said.
Hezbollah has continued rocket attacks on northern Israel - 70 were fired on Friday alone.
A mother and daughter died in an attack on the town of Meron. Two Israelis died in attacks on Thursday.
The crisis began when Hezbollah guerrillas seized two Israeli soldiers in a cross-border raid from Lebanon on Wednesday. Eight Israeli troops were also killed.
Israel responded with a major offensive - its biggest in more than two decades. The targets included not only Hezbollah positions but strategic sites like main roads, bridges and Beirut's international airport.
Residential areas near Hezbollah positions have been hit in air strikes, the group said.
Israel has warned residents by leaflet to stay away from Hezbollah locations.
Israel's chief of staff, Dan Halutz, said the two captured Israeli soldiers were still alive.
A third soldier, captured by Palestinian militants in the Gaza Strip where Israel is conducting a separate operation, is also still alive, he said.
Calls for restraint
In an emergency meeting of the UN Security Council, Lebanon called for an end to the Israeli operation.
The offensive was destroying infrastructure and causing the death of innocent civilians in full view of the international community, said Nouhad Mahmoud, Lebanon's ambassador to the UN.
Israeli Ambassador Dan Gillerman said Israel had no choice but to react to Hezbollah's aggression, describing the group as "merely the finger on the bloodstained and long-reaching arms of Syria and Iran".
The escalation has sparked international calls for restraint.
French President Jacques Chirac said the Israeli air strikes were "completely disproportionate" and the Vatican described them as an attack on a sovereign and free nation.
Mr Olmert said he would agree to a ceasefire if Hezbollah returned the two captured soldiers and stopped firing rockets at northern Israel, and Lebanon implemented UN Security Council resolution 1559, calling for the disarmament of the militant group.
Hezbollah has said the captured soldiers will not be returned without a release deal for Palestinian, Lebanese and other Arab prisoners held in Israeli jails.