Officials say Tamil Tiger rebels posing as fishermen entered Galle in a flotilla of small boats, and rammed some of the explosive-packed vessels into navy gunboats anchored in the harbor. At least two of the navy boats were damaged.
The incident sparked sporadic rioting in the seaside town. Shops belonging to the minority Tamil community were attacked in some areas.
Authorities have imposed a curfew and increased security, and they say the city is now calm.
Monday, more than a 100 people, mostly sailors, were killed when suspected guerrillas targeted a military convoy in the center of the country. Last week, a deadly battle in the north claimed the lives of hundreds of troops and rebels.
The Liberation Tigers of Tamil Eeelam, as the rebels are officially named, have been carrying out suicide bombings for almost 20 years. Analysts and government officials believe the latest attacks are an attempt by the rebels to demonstrate their strength before they sit down for peace talks scheduled to be held in Geneva later this month.
But Patlitha Kohona, the head of the government peace secretariat, says such tactics will not work.
"They have done this in the past also," Kohona says. "I assume they believe that by using terror tactics, they could intimidate the government. They are committing a big mistake. The government's objective is to negotiate an honorable peace. By using terror tactics, by using intimidatory tactics, I do not think the Tamil Tigers will be able to influence the government in any way."
The latest attack occurred in an area that is not usually involved in Sri Lanka's deadly ethnic conflict. The civil war between Tamils and the majority Sinhalese has been raging mainly in the Tamil-dominated north and east of the country.
Galle, by contrast, is located at the southwestern corner of Sri Lanka, about 100 kilometers south of Colombo. It is a popular tourist destination, and is also the country's main southern naval port.
Hours after the attack, government warplanes bombed rebel-held territory in the east. The rebels say the bombs killed a woman and wounded two civilians. The air force has been carrying out retaliatory attacks since April, when hostilities intensified between the two sides.
The sporadic fighting has claimed more than two-thousand lives this year, even though both sides claim they are still committed to a 2002 ceasefire, and to negotiating a peaceful solution. The conflict first erupted in 1983, when the rebels began fighting for an independent homeland for the minority Tamil community.