The rebel Liberation Tigers of Tamil Eelam (LTTE) said they sank two Dvora gunboats and damaged a third in close-quarter fighting off the island's northern peninsula of Jaffna and estimated navy losses at 25 killed.
"We did not use any suicide boats," LTTE spokesman Rasiah Ilanthiriyan said, denying defence ministry reports that a Tiger explosive-laden boat rammed a gunboat and sank it and destroyed another.
Ilanthiriyan said they boarded the second Dvora, removed all weapons and ammunition aboard and then set it ablaze and sank it. He placed Tiger losses at five killed and said they had also captured the body of one dead Sri Lankan sailor.
The ferocious battle came as peace broker Norway expressed concern over the deteriorating situation in the island where Oslo has been trying to broker peace at the invitation of the government and the LTTE.
Norway's International Development Minister Erik Solheim said Oslo had also demanded an immediate explanation from the Sri Lankan government over an attack near unarmed Nordic truce monitors on Wednesday in the island's north.
"It is very worrying that the civilian Sri Lanka Monitoring Mission (SLMM), headed by Lars Solvberg, came close to being hit by grenades fired by the Sri Lankan army near Pooneryn," Solheim said in a statement.
"We have asked the Sri Lankan government for an immediate explanation," he added.
The defence ministry denied targeting the monitors and said it had "not been informed of any SLMM movements" in that area.
The strongly-worded Norwegian statement came as the military accused the Tigers of using civilians as a shield to launch attacks against security forces and trying to hit a vessel carrying 308 civilians to the Jaffna peninsula. The Tigers deny attacking the civilians ship.
The passenger ferry was unharmed, but two Dvora gunboats in the area were destroyed, military spokesman Prasad Samarasinghe said adding that the Tigers used suicide boats in the attack, a charge denied by the rebels.
He said casualties were not immediately clear. Dvora gunboats are usually manned by a crew of 10 to 15 in each.
Samarasinghe said the navy, together with the support of supersonic jets and helicopter gunships, attacked rebel boats and destroyed 22 of them.
Meanwhile, President Mahinda Rajapakse ordered an investigation into Wednesday's military attack that led to the killings of a large number of civilians in the island's east.
"President Rajapakse expresses his deep sorrow and regret at the senseless loss of life of innocent civilians at Vakarai and condemns the LTTE's tactics of directing long range artillery fire using human shield that led to this tragedy," the government said in a statement.
It said the authorities had been ordered to pay compensation to the affected families and security force commanders were directed to investigate.
The military said that about 1,000 civilians crossed over to government-held areas on Thursday seeking shelter after Wednesday's attacks.
The Tigers had opened fire by evening to prevent more people leaving their areas, Samarasinghe said.
The SLMM said rockets had been fired into school buildings housing a large number of displaced Tamil civilians. Tamil rebels and medical sources said at least 65 people were killed and about 300 wounded, 130 of them seriously.
The International Committee of the Red Cross urged both sides to spare civilians, while London-based rights watchdog Amnesty International condemned the attack on the refugee centre and demanded an immediate probe.

Copyright AFP (Agence France-Presse), 2006