Suspected Tamil Tiger fighters staged an audacious suicide attack against Sri Lanka's historic port of Galle, in the deep south, destroying three navy craft, officials told AFP.
Galle is a popular tourist destination regarded as Sri Lanka's Riviera.
The attack on the naval base in the harbour was staged by fifteen attackers in five boats and triggered Sinhala mob violence against Tamil businesses in the southern town.
Two boats landed and attackers carried out rocket propelled grenade (RPG) attacks on the habour while three explosives-laden boats rammed and sank three naval craft.
RPG fire and exchanges of gunfire were reported for more than two hours.
Police told AFP they believed four or five Tigers may have escaped after the attack.
Police said authorities were still clearing the port area where offshore there are 26 diving sites and 15 ship wrecks dating back 400 years when Galle was a key transit point in the sea silk route to the Orient.
The main Karapitiya hospital here said a sailor and a civilian were killed and 15 injured sailors and eight civilians were still being treated.
Police moved to enforce a curfew clamped to prevent violence in this Sinhalese-majority city after constables opened fire and wounded three men attacking shops owned by Tamils.
Tamil civilians have sought refuge at two Hindu temples in Galle. Police said the civilians were safe as the temples were being heavily guarded by the Sri Lankan police and military.
There were no immediate reports of foreigners among the casualties in Galle, the country's third largest city.
The United States has warned its citizens against travelling to Galle, 110 kilometres (70 miles) in the wake of the attack. On Tuesday, the US embassy warned on its website of possible attacks in the Sri Lankan capital as, it said, the Tigers have a history of indiscriminate attacks in Colombo.
The city of Galle got its name from a Portuguese fleet that landed there in 1505. The military maintains a base and stores its ammunition there and the harbour shares space with merchant shipping and foreign yachts.
The Tigers last hit the Galle port area in December 1997 when they detonated a truck bomb that was targeting the navy commander at the time.