"A terrorist murdered a civilian in her home in the community of Otniel," south of Hebron, a military statement said.
"The attacker broke into the house and stabbed the victim to death. Forces are in pursuit of the terrorist."
Palestinians in neighbouring villages said a major manhunt was under way, with army helicopters in the sky and heavy movement of military vehicles.
Further details were not yet clear on the stabbing, the latest in more than three months of attacks but the first in the current wave of violence to take place inside a settlement home.
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Many of the Palestinians killed have been attackers, while others have been shot dead by Israeli forces during protests and clashes.
Otniel is located near the city of Hebron in the south of the Israeli-occupied West Bank.
Hebron, where several hundred Israeli settlers live in the city centre among around 200,000 Palestinians, has been a flashpoint in a wave of Palestinian knife, gun and car-ramming attacks that began in October.
Israel's government has come under heavy pressure over the continuing stabbings, and Sunday's killing was likely to further boost tensions.
A large amount of the Palestinian attackers have been young people, including teenagers. A number of them have attempted attacks with kitchen knives in what some analysts have described as virtual suicide missions.
Some analysts say the attacks have been in part driven by frustration with the complete lack of progress in peace efforts, Israel's continuing occupation of the West Bank and their own fractured Palestinian leadership.