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By Waleed Ibrahim

BAGHDAD, June 9 (Reuters) - Iraq's Foreign Ministry accused Turkey of "intensively shelling" northern Iraq this week and said it had handed the Turkish envoy in Baghdad a protest letter on Saturday.

A Foreign Ministry statement said the shelling caused "huge damage" in the mountainous northern Kurdish provinces of Dahuk and Arbil.

A ministry spokesman said the shelling took place over three hours late on Wednesday and early Thursday.

"This attack caused wide fires and huge damage in the area and made citizens fearful," the ministry statement said, without precisely identifying the damage.

Financial markets were rattled by a report late on Wednesday that Turkey had launched a major incursion across the border into northern Iraq to crush Kurdish rebels.

Turkey denied the report, but a military source said troops had conducted a limited raid, a not unusual incursion into the mountains in northern Iraq where 4,000 rebels of the outlawed Kurdistan Workers Party (PKK) are said to be hiding.

Iraqi Deputy Foreign Minister Mohammed al-Haj Hamoud handed the protest letter, which called for talks between the two governments, to the Turkish ambassador to Iraq in Baghdad.

"Such an action could affect the confidence between both countries and affect the friendly atmosphere between both governments," the statement said of the shelling.

Iraq's prime minister and president have repeatedly called for dialogue with Turkey in recent days to resolve the growing tensions. Washington has also urged Turkey not to undertake unilateral military action.

Turkey's military is known to sometimes shell PKK targets inside Iraq, as well as stage small "hot pursuit" raids across the border.

Turkey's Foreign Ministry was not immediately available for comment. Ankara routinely declines to comment on reports of military activity on or across its border with Iraq.

The protest letter was delivered as thousands of people took to the streets in Turkey's mainly Kurdish southeast in a state-sponsored demonstration against separatist violence in a remote hillside town 50 km (30 miles) from the Iraq border.

Turkey has been increasingly exasperated by PKK attacks on its soil, and by the failure of its U.S. allies to tackle the PKK rebels. It has sent more tanks and troops to the border region, sparking fears of a major incursion into Iraq.

Turkey's army General Staff has also repeatedly said it will respond to attacks by the PKK against civilian and military targets in Turkey.

But analysts say the chances of a large-scale military incursion are low because of the political, diplomatic and security risks.

Ankara blames the PKK for more than 30,000 deaths since the group launched its armed campaign for an ethnic homeland in southeast Turkey in 1984.

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