Hundreds of Palestinians had fled their homes for the refuge of the al-Fakhoura school, hoping the blue and white flag of the UN flying over the impromptu shelter would protect them from the Israeli onslaught.

The UN had even given the Israeli army the co-ordinates for the building to spare it from the shells and air strikes raining down on the Gaza strip. But yesterday afternoon tank shells exploded outside the school, sending shrapnel into the crowds, killing at least 40 and wounding another 55.

It was the worst confirmed bloodshed of Israel's attack on Gaza and sparked outrage and condemnation around the globe, with the US President-elect Barack Obama breaking his 11-day silence, the UN Secretary Ban Ki-moon calling the incident "totally unacceptable" and Gordon Brown describing the conflict as "the darkest moment yet for the Middle East".

Within hours of the strike on the school, with the Palestinian death toll topping 600 and pressure mounting on Israel to stop its crushing military campaign, Egypt proposed an immediate ceasefire and talks with Israel and Hamas on a long-term settlement, including an end to the Gaza blockade.

French President Nicolas Sarkozy, who was in Cairo on the latest stop of a two-day tour of the Middle East, said that his Egyptian counterpart, Hosni Mubarak, was inviting "notably the Israeli side to discuss the issue of border security without delay".

Arriving in New York for an emergency UN Security Council meeting, David Miliband, the Foreign Secretary, welcomed the statement by Mr Mubarak saying it "underlined the fast-moving nature of events". The world, Mr Miliband told the Council, was witnessing in Gaza, "the horror of war piled upon months of deprivation".

At the meeting, Palestinian President Mahmoud Abbas voiced support for the Sarkozy-Mubarak ceasefire initiative. The killings at the school in Gaza confirmed the "heinous crime being committed against our people," he said.

Israel had yet to respond to the initiative last night. However, a statement was issued late in the evening anncouncing Israel's willingness to set up a "humanitarian corridor" into Gaza for the safe delivery of emergency supplies "to prevent a humanitarian crisis" there.

The US Secretary of State, Condoleezza Rice, said Washington backed Mr Mubarak's ceasefire proposal. "We need urgently to conclude a ceasefire that can endure and that can bring real security," she told the Security Council. "In this regard we are pleased by and wish to commend the statement of the President of Egypt and to follow up on that initiative."

With Israeli troops moving further south into the cities of one of the world's most crowded territories, the Palestinian death toll is beginning to rival that in Lebanon in the summer of 2006. Yesterday, the UN demanded an immediate independent investigation into the latest school killings.

The emergency room of northern Gaza's Kamal Adwan hospital was packed to overflowing after the carnage. "We have become quite used to noises of explosions but then they started bringing in all those who had been caught in the attack and it was a very bad sight," Dr Bassam Abu Warda told The Independent.

"It was terrible, really terrible. We are living at a very difficult time but even as doctors it is always hard to see children being hurt and we had a lot of them today and we are not really equipped to deal with this type of emergency here."

Majed Hamdan, a photographer, said he rushed to the scene shortly after the attacks, which happened just as many of the refugees had ventured outside for fresh air. "I saw women and men – parents – slapping their faces in grief, screaming, some of them collapsed to the floor," he said. "They knew their children were dead."

Gruesome footage on Hamas's al-Aqsa TV showed medics starting to unload the bodies of men who had been stacked up in the back of an ambulance, three high, and were dragged out without stretchers. The blood-caked stumps of one man's legs bumped along the ground as he was pulled from the ambulance.

Responding to criticism of its hit on the school in the Jabalya refugee camp, the Israeli military accused Hamas of "using civilians as human shields". It said that the results of its "initial inquiry" was that mortar shells had been fired from the school at forces operating in the area and that, "in response to the incoming enemy fire, the forces returned mortar fire", and said that this was not the first time Hamas had fired mortars and rockets from UNRWA school premises in Gaza. Two Hamas militants, Imad Abu Askar and Hasan Abu Askar, were among the dead, the army said.

John Ging, the operations director for the UN Relief and Works Agency, which runs the school, expressed his outrage. "Those in the school were all families seeking refuge," he said. "There's nowhere safe in Gaza. Everyone here is terrorised and traumatised ... I am appealing to political leaders to get their act together and stop this."

Ahead of the Security Council session, there were signs of tension between the White House and the US State Department. "We would like an immediate ceasefire, absolutely," a department spokesman, Sean McCormack, told reporters before Ms Rice's departure for New York. "An immediate ceasefire that is durable, sustainable and not time-limited." Minutes later, the White House said this did not represent a shift in the US position.

Veering away from his mantra of "one president at a time", Mr Obama said "the loss of civilian life in Gaza and Israel is a source of deep concern for me." Gordon Brown said: "This is a humanitarian crisis. This is the darkest moment yet for the Middle East and it affects the whole world."

Al-Qai'da's second-in-command, Ayman al-Zawahri, made an internet appeal for Muslims to "hit the interests of Zionists and Crusaders wherever and whichever way you can".

While the school killings represented the single biggest loss of life since the Israeli offensive began on 27 December, details are emerging of other incidents involving high numbers of civilian casualties. An Israeli human rights agency, B'Tselem, and the UN's Office for the Co-ordination for Humanitarian Affairs (OCHA) independently released reports that more than 30 members of the same extended family had been killed on Monday during the shelling of a building in the northern Zeitoun district of Gaza City.

With foreign journalists currently prevented from entering Gaza and with mobile telephone use in Gaza intermittent, it is virtually impossible to verify details of all casualties.

In Israel, the Hamas rockets have continued to land. At least five hit Israeli soil yesterday, including one in Gadera, 28km (17 miles) from Tel Aviv. A three-month-old baby was hurt.

The Israel Defence Forces says seven Israeli soldiers have died during the offensive: one during the air strikes, three more since the ground invasion began and, late on Monday, three were killed and another 24 wounded by a tank shell in a friendly fire incident.