The shooting broke out around Manger Square, the site of both the church and the Peace Centre, where the talks were to be held. Palestinian lawyer Tony Salman, who has been inside the church since the start of the siege, told reporters that two Palestinians in the building were wounded.
At the same time, Palestinian negotiator Imad Nache said an Israeli soldier in the Peace Centre was also hit.
The burst of shooting from the direction of the besieged church sent both foreign and Israeli journalists and the Palestinian negotiation team scurrying for cover at the edge of the square.
After the shooting, Israeli soldiers allowed Israeli journalists to enter the Peace Centre but told the foreign press to leave within 10 minutes or face arrest.
When the foreign journalists did not leave, troops fired tear gas at them and arrested three of them.
The rest of the 40 or so journalists at the scene then left. As they were leaving, Salman and a priest were seen carrying one of the wounded Palestinians out of the front entrance of the church.
Talks appeared to have started despite the shooting.
Powell: 'No evidence of Jenin massacre'
In Washington, US Secretary of State Colin Powell said on Wednesday he had so far seen no evidence of a massacre or mass graves at the Palestinian refugee camp at Jenin.
"Right now I've seen no evidence of mass graves and I've seen no evidence that would suggest a massacre took place," Powell told a Senate committee hearing, basing his remarks on a visit to the camp by a State Department official last week.
Powell also said he had spoken with Israeli Prime Minister Ariel Sharon on Tuesday evening and understood his concerns about the UN fact-finding mission being sent to Jenin, but said such a mission was in the best interests of all sides.
He said this was preferable to "the coarse speculation that was out there as to what happened, with terms being tossed around like massacre and mass graves, none of which so far seems to be the case".
"Clearly people died in Jenin, people who were terrorists died in Jenin and in the prosecution of that battle innocent lives may well have been lost," he said, but further investigation was needed on the ground to assess the facts.
Fielding questions from senators who made clear their sympathy with Sharon's military assault on the camp, part of an extensive military onslaught after a series of suicide bombings by Palestinians, Powell said the camp had been hugely damaged.
Palestinians said Israeli troops committed a massacre and that hundreds died in the operation. Israel says 48 people were killed while it lost 23 soldiers.
UN fact finders meet in Geneva
And in Geneva a United Nations fact-finding team assigned to probe the Israeli army's assault on the refugee camp in the West Bank town of Jenin assembled as planned on Wednesday.
Finland's former president, Martti Ahtisaari, who is to lead the team, Cornelio Sommaruga, the Swiss former head of the International Committee of the Red Cross (ICRC) and Sadako Ogata of Japan, former UN High Commissioner for Refugees, met at the UN's European headquarters here.
They declined to make any comment but UN spokesperson Marie Heuze said a statement would be issued later.
She said more experts supporting the mission would arrive here on Thursday.
The gathering in Geneva comes a day after UN Secretary-General Kofi Annan agreed to briefly delay the departure of his fact-finding team to discuss possible changes after Israel voiced objections about its composition.
In Middle East by Saturday
But Annan made it clear that he stood by the three team leaders, and expected the mission to be in the Middle East by Saturday.
The mission will be backed up by a group of advisors, including a retired US general, William Nash, to act as military advisor and a senior Irish police officer, Peter Fitzgerald, to deal with police matters. Both men served in UN military forces in Bosnia.
Annan "did not rule out adding additional experts as might be deemed necessary," his office said on Tuesday.
Israelis and Palestinians are at loggerheads about the scale of destruction and casualties in Jenin after fierce fighting there.
Saying it had nothing to hide, Israel agreed to the mission on Friday after pulling out of Jenin, the scene of fierce fighting with gunmen in a camp the army had branded a "nest of suicide bombers".
Powell said in Washington he believed the UN mission, which has been delayed pending talks between an Israeli delegation dispatched to discuss it with Annan, would be objective.
Sharon on Tuesday backed away from his commitment, saying he wanted changes to the team's make-up, insisting on anti-terrorist and military experts.
Mary Robinson reports to UN
As the team assembled, UN High Commissioner for Human Rights Mary Robinson presented a report to the UN's top human rights forum here, calling on Palestininas and Israelis to stop the fighting to accept a "comprehensive" independent investigation.
Last Friday Robinson called off another planned fact-finding mission to the region, which had received backing on April 5 from the 53 member UN Human Rights Commission.
Her office said the planned rights mission had failed to receive a green light from the Israeli authorities in time and Robinson would put together the report based on information from the region.
Israel said it had not rejected Robinson's proposed mission. - Sapa-AFP and Reuters