(Updates to show hostage handover completed, paragraphs 1,3,4)

By Nidal al-Mughrabi

GAZA, Jan 30 (Reuters) - Rival Palestinian factions swapped hostages on Tuesday under a ceasefire deal that went into effect hours earlier, largely halting gun battles in which at least 30 Palestinians were killed.

The internal Palestinian violence in the Gaza Strip had been the fiercest since the Islamist Hamas group, which rejects peace talks with Israel, trounced the more moderate Fatah faction in elections last year, triggering a Western aid embargo.

A total of 20 Hamas and 18 Fatah hostages were freed over a several hour period, said Samih al-Madhoun, a senior leader of al-Aqsa Martyrs Brigades, the armed wing of Palestinian President Mahmoud Abbas's Fatah.

"The process of handing over the hostages has been completed," Madhoun said.

The truce agreed late on Monday to end five days of fighting seemed to be generally holding despite the killing of a Hamas commander in Gaza on Tuesday.

The ceasefire went into effect after Prime Minister Ismail Haniyeh of Hamas met an aide to Abbas.

The bloodshed had derailed unity government talks between Hamas and Fatah and prompted some families in the coastal strip to flee their homes.

Shops and schools shut down as the sounds of gun battles echoed across the narrow, densely populated territory where 1.5 million Palestinians live.

SHOPS REOPEN

As the ceasefire went into effect, people came out of their homes for the first time in five days and shops reopened. Traffic again clogged Gaza's streets.

Gunmen from both factions removed checkpoints they had set up during the clashes, but some Fatah fighters remained visible in Gaza City.

"We are very happy and we hope that this time, the ceasefire will last," said Yahya Zaki, a clothing shop owner.

Previous ceasefires, including one last month, have been short-lived.

The truce was initially threatened when Hamas blamed the Fatah-dominated Preventive Security Service for the killing of one of its commanders, Hussein Shabasi.

Hospital officials said Shabasi was shot in the head in the town of Khan Younis. The security service denied any connection with his death.

Talks to implement the truce went ahead as planned.

Before the release of hostages began in Gaza City, Fatah and Hamas officials handed each other lists of people being held.

A day after a suicide bomber from Gaza killed three people in Israel's Red Sea resort of Eilat, Israeli Defence Minister Amir Peretz vowed to take action but gave no hint as to when, where or against whom the military would strike.

"The initiative will be ours and we have no intention of relaying what we plan to do," Peretz said in broadcast remarks during a visit to the border with Egypt, near Eilat.

With international mediators due to meet in Washington on Friday in a bid to revive Israeli-Palestinian peacemaking, Israel could be wary of taking action that might jeopardise a diplomatic drive promoted by its main ally, the United States.

The so-called Quartet of mediators comprises the United States, Russia, the European Union and the United Nations.

In remarks on Monday after the Eilat attack, Peretz said Israel would "do everything to preserve" its two-month-old Gaza ceasefire with militant groups.

The suicide bombing, claimed by Islamic Jihad and al-Aqsa Martyrs Brigades, was the first in Israel in nine months.

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