South Korea accused the reclusive North of torpedoing one of its warships, heightening tension in the economically powerful region and testing the international position of China, Pyongyang's only major backer.
South Korea said it would take "firm" measures against its impoverished neighbour, which furiously responded that it was ready for war if Seoul or its allies imposed sanctions.
A report by investigators, including experts from the United States, Australia, Britain and Sweden, concluded that a North Korean submarine had fired the torpedo which sank the Cheonan corvette in March, killing 46 sailors.
"There is no other plausible explanation," their report said.
Financial markets in Seoul showed little reaction to the widely anticipated findings of the report but were watching nervously for any serious escalation in tensions
"The key is what kind of measures South Korea will take and how North Korea will react to them," said Choi Seong-lak, an analyst at SK Securities.
"If things become violent it will affect foreign investors, but for today the impact from the result itself will be limited."
International condemnation was immediate, with the stark exception of China, which analysts say is desperate to avoid any action that might destablise its reclusive neighbour and lead to a spill-out into in its territory.
A senior South Korean government official said previously that the attack appeared to have been in revenge for a firefight near the disputed North-South border late last year in which the North's navy was humiliated.
UN Secretary-General Ban Ki-moon called the contents of the South Korean investigation deeply troubling..
Both the United States and Britain gave their backing to the findings, with the White House calling it an act of aggression that was another sign of the North's unacceptable behaviour.
China simply termed the sinking "unfortunate". Vice Foreign Minister Cui Tiankai declined to comment on the South Korean report and urged stability on the peninsula.
South Korean President Lee Myung-bak will hold an emergency meeting of his National Security Council on Friday. His government has already made clear it has no plans for a retaliatory strike of its own but will be pressing the international community to take action, probably more sanctions, against the North.
"We will be taking firm, responsive measures against the North, and through international cooperation, we have to make the North admit its wrongdoing and come back as a responsible member of the international community," Lee was quoted by his office as telling Australian Prime Minister Kevin Rudd.
The report, announced in a nationally televised news conference, said intelligence had shown that North Korean submarines were likely in operation near the scene of the sinking, with similar vessels of other neighbouring countries all inside their territorial waters.
"The evidence points overwhelmingly to the conclusion that the torpedo was fired by a North Korean submarine," it said.
The issue has plunged already icy relations between the two Koreas deeper into the freezer.
North Korea said the South's conservative government was using the incident for political gain and to further undermine ties between the two Koreas, which have yet to sign a formal peace treaty to end their 1950-53 war.
"Our army and people will promptly react to any 'punishment' and 'retaliation' and to any 'sanctions' infringing upon our state interests with various forms of tough measures including an all-out war," its official news agency quoted the powerful National Defence Commission as saying in a typically florid statement..
The issue also puts China in a tricky spot. The host of on-again, off-again regional talks to rein in North Korea's nuclear weapons programme is the reclusive state's only major ally and is reluctant to penalise its government.
"It's going to be very, very difficult for China to navigate this one. The South Koreans are not particularly pleased about what China's doing," said Charles Freeman, China expert at the Center for Strategic and International Studies in Washington.
Seoul is already upset with Beijing, a major trading partner, for hosting North Korean leader Kim Jong-il on a rare trip abroad before the outcome of the investigation was announced.
But there have been media reports in the South that Chinese leaders may not have given the frail-looking Kim as much support as he wanted, speculating ties may now be starting to fray.
Paik Jin-hyun, a North Korea expert at Seoul National University, said tension between the two Koreas was inevitable.
"North Korea has given out war threats before and they are doing this now because the situation has become urgent for them. They will try to block sanctions at all costs. In this heightened state of affairs, provocations may occur."