KIEV - Russian President Vladimir Putin on Friday hailed the advances of pro-Kremlin fighters in eastern Ukraine as Western alarm spiralled over what Kiev has branded a Russian invasion.
NATO ambassadors were holding a crisis meeting after the alliance said Russia had at least 1,000 troops fighting to support a lightning rebel counter-offensive against Ukrainian government forces.
The presence of the troops - which Russia has repeatedly denied - has stoked fear of a direct confrontation between Kiev and and its former Soviet masters.
Putin symbolically hailed the insurgents as the defenders of New Russia, a Tsarist-era term for Moscow's former imperial holdings in the region that Putin has revived since annexing Ukraine's Crimea peninsula in March.
The West warned of "consequences" as US President Barack Obama said it was obvious Russian troops were fighting to support separatist attacks that have reclaimed swathes of territory and surrounded government troops.
"Russia has deliberately and repeatedly violated the sovereignty and territorial integrity of Ukraine, and the new images of Russian forces inside Ukraine make that plain for the world to see," he said.
"This ongoing Russian incursion into Ukraine will only bring more costs and consequences for Russia." Putin brushed off Western concern, instead praising rebel successes in halting Kiev's advances in a counter-offensive in the southeast that has left government troops battling for survival in the town of Ilovaysk.
"I call on the rebel forces to open a humanitarian corridor for the Ukrainian troops who are surrounded, so as to avoid unnecessary casualties and to give them the opportunity to withdraw from the zone of operations," Putin said in a statement.
Top rebel leader Alexander Zakharchenko agreed to Putin's appeal, telling Russian television that "out of all due respect for Vladimir Putin" his men would be willing to let Kiev troops withdraw if they give up their weapons.
Ukrainian security chiefs lashed out at the Russian proposal, saying in a statement it proved "these people are directed and controlled directly from the Kremlin".
German Chancellor Angela Merkel has said European leaders would discuss possible new measures against Moscow at a summit in Brussels on Saturday, after Kiev appealed for help from NATO and the EU.
The United States and the European Union have already imposed a series of punishing sanctions on Moscow over the crisis, the worst standoff between Russia and the West since the Cold War.
According to new UN figures issued Friday, almost 2,600 have been killed since April when the separatists launched their insurgency against Kiev's rule.
The latest tensions sent the Russian ruble nosediving to a record low against the dollar on Friday.
Asian stock markets also tumbled after fears of all-out war caused bourses in Europe and the US to plummet on Thursday.
At an emergency meeting of the UN Security Council, US envoy Samantha Power demanded that Russia "stop lying".
"We see Russia's actions for what they are: a deliberate effort to support and now fight alongside illegal separatists in another sovereign country." Kiev said on Thursday that Russian soldiers had seized control of a key southeastern border town and a string of villages in an area where fighting had been raging for days.
Surrender or be shot
AFP journalists saw smoke rising from fighting around Ilovaysk, some 50 kilometres (30 miles) southeast of the main rebel hub Donetsk as fighters demanded government troops surrender or die.
Fighters loyal to Ukraine have been engaged in a desperate fight for survival against the rebels in the strategic transport hub for over a week.
"Anyone who surrenders and waves the white flag, will not be shot," a rebel fighter called "Klasik" said.
A NATO official said Thursday that at least 1,000 Russian troops were on the ground and that the supply of weapons to the rebels had increased in both "volume and quantity." The latest tensions come just days after President Petro Poroshenko and Putin held their first meeting in three months, but failed to achieve any concrete breakthrough despite talk of a peace roadmap.
The latest claims of Russian manoeuvres are sparking fears that Putin is seeking more than Crimea, which it annexed in the face of Western outrage.
Russian Foreign Minister Sergei Lavrov insists the Kremlin is "not interested in breaking up" Ukraine.
But Russia vehemently opposes closer ties between Ukraine and NATO.
And concerns that Kiev could be drawn closer into the Western security alliance - and towards Europe - are seen as a key motivation behind Russia's actions in recent months.