(Updates toll, adds background)

By Nidal al-Mughrabi

GAZA, Jan 1 (Reuters) - Hamas and Fatah fighters waged gun battles in the Gaza Strip on Tuesday that raised to seven the number of people killed in the deadliest clashes between the rival Palestinian factions in months.

The fighting began on Monday when Fatah supporters gathered to mark their group's anniversary in defiance of a ban by the territory's Islamist rulers.

Gunmen armed with automatic rifles, rocket-propelled grenades and mortar bombs fought it out in Gaza City. Smoke rose from burning cars and several houses were heavily damaged.

Medical workers said four Hamas men and three Fatah supporters had been killed since Monday.

Hamas seized control of the Gaza Strip in June, routing the Fatah forces of President Mahmoud Abbas. Seven people were killed in November when a massive Fatah rally to mark the third anniversay of the death of Palestinian leader Yasser Arafat ended in gunfire.

On Monday, Abbas urged Hamas to agree to early elections, cede control of the Gaza Strip and hold reconciliation talks with Fatah. The next Palestinian parliamentary election is due in 2010.

Hamas swept a 2006 election but has been shunned by the West because of its refusal to recognise Israel, renounce violence and abide by existing interim Israeli-Palestinian peace accords.

Responding to Abbas's election call, Mahmoud al-Zahar, a Hamas leader, told a news conference: "An early ballot is completely rejected."

Zahar said Abbas's offer of a dialogue would be credible only if the Palestinian Authority "freed all political detainees" and halted its "campaign of pursuit" against Hamas activists in the West Bank, where Fatah holds sway.

Urging Abbas not to trust Israel or the United States, Zahar said: "If you extend a hand to Hamas, you will make history. But if you do the opposite, then history will show no mercy."

Abbas and Israeli Prime Minister Ehud Olmert agreed at a U.S.-hosted summit in Annapolis, Maryland in November to restart Palestinian statehood talks try to reach a peace deal before U.S. President George W. Bush leaves office in January 2009. (Writing by Jeffrey Heller; Editing by Richard Balmforth)

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