FOREIGN Minister Bob Carr has urged Israel and the Palestinians to exercise restraint, saying a rocket attack on Jerusalem signifies a dramatic escalation of the worsening Middle East conflict.

Militants in the Gaza Strip fired rockets at Jerusalem and Tel Aviv on Friday, further inflaming tensions and increasing the chances that Israel will send in troops to take on Hamas.

Israel is massing troops at the Gaza border and has given its approval for the recruitment of up to 75,000 reservists.

Senator Carr said both sides should draw back from the brink of war.

''I understand Israel was already considering ground action,'' Senator Carr told Sky News on Saturday.

''That was before these rocket attacks, so it's extremely serious and a dramatic escalation that has us again, as Australians, calling for both sides to exercise a high degree of restraint.''

Israeli ambassador to Australia Yuval Rotem acknowledged the calls for restraint. ''The question is if we exercise restraint and the rockets continue to come all the way from Gaza, how are we going to stop it?'' he said. ''The rockets need to be stopped.''

The Jerusalem and Tel Aviv rockets were the furthest Gaza militants have ever fired into Israel. Neither rocket killed anyone nor caused significant damage.

As tension mounted in the region, the Atomic Energy Agency also announced on Saturday that Iran had expanded its enrichment capacity at a pace that would bring it to what Israel has declared an unacceptable red line in a little more than seven months.

The International Atomic Energy Agency (IAEA) also found that Iranian technicians had removed the fuel rods from the country's only functioning nuclear power station at Bushehr, suggesting the new reactor has serious problems. Iran did not tell IAEA inspectors what those problems were.

The IAEA quarterly report on Iran's nuclear programme comes soon after Israeli officials stated the red line drawn by Israel's Prime Minister, Benjamin Netanyahu, during his UN appearance in September, represented 240 kilograms of 20 per cent enriched uranium, enough to be turned into weapons grade relatively fast and easily.