(Adds Kerry, Hagel comments, paragraphs 4-6, 17)
* Kiev Interior Ministry forces, army take rebel checkpoints
* Putin warns of consequences after "punitive operation"
* Kerry says Moscow's window to change course "is closing"
By Aleksandar Vasovic and Alexei Anishchuk
SLAVIANSK, Ukraine/ST PETERSBURG, Russia, April 24 (Reuters)- U krainian forces killed up to five pro-Moscow rebels onThursday as they closed in on the separatists' militarystronghold in the east, and Russia launched army drills near theborder in response, raising fears its troops would invade.
The Ukrainian offensive amounts to the first time Kiev'stroops have used lethal force to recapture territory from thefighters, who have seized swaths of eastern Ukraine since April6 and proclaimed an independent "People's Republic of Donetsk."
Ukraine's acting president accused Moscow of supporting"terrorism at the state level" against his country for backingthe rebels, whom the government blames for kidnapping andtorturing a politician found dead on Saturday.
"The window to change course is closing," U.S. Secretary ofState John Kerry warned in a hastily arranged appearance in theState Department, where he cited President Barack Obama'scomments earlier on Thursday that Washington was ready to imposenew sanctions if Moscow did not alter its policy.
In unusually blunt comments, Kerry accused Russia of usingpropaganda to hide what he said it was actually trying to do ineastern Ukraine - destabilize the region and undermine nextmonth's planned Ukrainian presidential elections.
"So following today's threatening movement of Russian troopsright up to Ukraine's border, let me be clear," Kerry said. "IfRussia continues in this direction, it will not just be a gravemistake, it will be an expensive mistake."
Russian President Vladimir Putin said sanctions were"dishonourable" and destroyed the global economy but that so farthe damage had not been critical.
The Ukrainian Interior Ministry said its forces backed bythe army had removed three checkpoints manned by armed groups inthe separatist-controlled city of Slaviansk.
"During the armed clash, up to five terrorists wereeliminated," it said in a statement, adding one person had beenwounded on the side of the government forces.
A rebel spokeswoman in Slaviansk said two fighters had diedin a clash in the same area, northeast of the city centre.Slaviansk's separatist self-proclaimed mayor, VyacheslavPonomaryov, quoted on a local news site, said one man was shotdead and another badly wounded on the northeastern outskirts ofthe city. He said the dead had been unarmed.
The Kremlin, which says it has the right to invade itsneighbour to protect Russian speakers, has built up forces onUkraine's border - estimated by NATO at up to 40,000 troops.
Defence Minister Sergei Shoigu announced Moscow had launchedmilitary drills near the border in response to "Ukraine'smilitary machine" and NATO exercises in Eastern Europe. Kievdemanded an explanation within 48 hours of action on the border.
Russia seized and annexed the Crimean peninsula from Ukrainelast month after President Vladimir Putin overturned decades ofpost-Cold War diplomacy by announcing the right to use militaryforce in neighbouring countries.
An invasion of mainland Ukraine's industrial heartland wouldbe a far more serious action. It had seemed beyond contemplationonly weeks ago but now looks like a real threat, although thefull extent of Putin's territorial ambitions remains a mystery.
In St Petersburg, Putin said that if the authorities in Kievhad used the army in eastern Ukraine, it would be a very seriouscrime against their own people.
"It is just a punitive operation and it will of course incurconsequences for the people making these decisions, including(an effect) on our interstate relations," Putin said in atelevised meeting with regional media.
U.S. Defence Secretary Chuck Hagel voiced concern aboutreports of Russian military activity, telling reporters during a visit to Mexico City: "This is dangerously destabilizing andit's very provocative."
Russia's Foreign Ministry responded that it was up toWashington to halt the Ukrainian military action, and "force theKiev authorities, who are wards of the United States, torestrain themselves and not use force."
Reuters journalists saw a Ukrainian detachment with fivearmoured personnel carriers take over a checkpoint on a roadnorth of Slaviansk in the late morning after it was abandoned byseparatists who set tyres alight to cover their retreat.
But two hours later, the troops pulled back and it wasunclear if Kiev would risk storming Slaviansk, a city of 130,000that has become the military stronghold of a movement seekingannexation by Moscow of Ukraine's industrialised east.
'FINISH WHAT WE HAVE STARTED'
At another checkpoint set up by the Ukrainian military, asoldier said they were there to instil law and order.
"Those separatists, they violated the constitution, they aretorturing the country, they violated laws, they do not recognisethe authority of police, so the army had to move in and we willfinish what we have started, so help me God," he said.
Under an accord signed by Russia, Ukraine, the United Statesand the European Union in Geneva last week, illegal armed groupsare supposed to disarm and go home, including the rebelsoccupying about a dozen buildings in the largelyRussian-speaking east.
Washington accuses Moscow of sending agents to coordinatethe unrest in the east, as it did before seizing Crimea lastmonth. Russia denies it is behind the uprising and says theseparatists are responding spontaneously to hostility from Kiev.Russia made similar denials over Crimea until Putin acknowledgedlast week his troops had indeed acted alongside local militia.
"At the state level, Russia is supporting terrorism in ourcountry," Ukraine's acting president, Oleksander Turchinov, saidin an address to the country on Thursday. "Armed criminals havetaken over buildings, are taking citizens, Ukrainian and foreignjournalists, hostage and murdering Ukrainian patriots."
Turchinov called for the eastern offensive this week afterthe apparent torture and murder of a pro-Kiev town councillorwhose body was found on Saturday near Slaviansk.
Volodymyr Rybak had disappeared after being filmed trying totake down a separatist flag while attempting to enter therebel-held town hall where he worked in Horlivka, nearSlaviansk.
"He was bruised and punctured from head to toe ... it'sclear they tortured him," said Aleksander Yaroshenko, a familyfriend who accompanied Rybak's widow when she identified hisbody at the morgue. "The police have lots of details, they haveCCTV footage, they should know who did this," he told Reuters.
Rebels in Slaviansk released U.S. citizen Simon Ostrovsky,one of three journalists they were believed to be holding.
Moscow called for Kiev to release "political prisoners",including a pro-Russian activist named Pavel Gubarev.
U.S. TROOPS ARRIVE IN POLAND
So far, the United States and the EU have taken only mildaction against Moscow, imposing visa bans and asset freezes on afew Russians, measures Moscow has scoffed at as meaningless.Washington and Brussels both say they are drafting more serioussanctions and will impose them if the Geneva deal collapses.
Even without serious sanctions, Russia's confrontation withthe West has hurt its economy as fearful investors send theirmoney abroad. Mutual funds specialising in Russia and EasternEurope were the 30 worst performers out of 3,489 equity fundsfor sale in Britain in the three months ending in March.
But Moscow also flexed its economic muscles, with thegovernment suggesting foreign firms that pull out of the countrymay not be able to get back in. A source at Gazprom said theRussian exporter had slapped an additional $11.4 billion bill onKiev. Ukraine is negotiating to reverse east-west pipelines sothat it can receive gas from Europe if Moscow cuts it off.
In NATO-member Poland, the first group of a contingent ofabout 600 U.S. soldiers arrived on Wednesday, part of an effortby Washington to reassure Eastern European allies who areworried by the Russian buildup near Ukraine's borders.
But NATO and the United States have made clear they will notuse military force to protect Ukraine itself.
Shoigu, the Russian defence minister, said aircraft wouldfly increased patrols near the Ukrainian frontier as part of thenew exercises. Two local residents in the area told Reuters theyhad seen attack helicopters flying in formation.
Kiev said the city hall in another eastern town, Mariupol,which had been seized, was back under central control. Aseparatist crowd later surrounded the building, patrolled bypolice but otherwise apparently empty.
Ukraine, a former Soviet republic, slid into unrest latelast year when Moscow-backed President Viktor Yanukovichrejected a pact to build closer ties with Europe. Protesterstook over central Kiev and he fled in February. Days later,Russian troops seized control of Crimea.
The Ukrainian Defence Ministry confirmed its involvement inthe operation around Slaviansk on Thursday, saying the troopsinvolved were airborne units with experience of such tasks frominternational peacekeeping missions.
Unarmed mediators from the Organization for Security andCooperation in Europe are in eastern Ukraine trying to persuadepro-Russian gunmen to go home, in line with the Geneva accord.
Reuters reporters have not been able to establish that anyRussian troops or special forces members are on the ground,although Kiev and Western powers say they have growing evidencethat Moscow has a presence. Masked gunmen in the east, widelyreferred to as "green men", wear uniforms without insignia. (Additional reporting by Alexander Reshetnikov and GlebGaranich near Slaviansk, Alissa de Carbonnel in Donetsk, PavelPolityuk, Natalia Zinets, Richard Balmforth and AlastairMacdonald in Kiev, Denis Dyomkin in Birobidzhan, Russia, MarkFelsenthal in Tokyo, Alessandra Prentice and Vladimir Soldatkinin Moscow, David Alexander in Mexico City, and Arshad Mohammedin Washington; Writing by Christian Lowe, David Stamp, PhilippaFletcher, Peter Graff and Peter Cooney; Editing by MohammadZargham)
