Xion's comments during battle imply that she wants Roxas to defeat her. It's implied that she is still in there, and wants Roxas to kill her so she won't have to destroy him.
The secret reports reveal that she was feigning her insanity. Doesn't make it less scary, though.
Right before said battle, Roxas goes up to the Clock Tower to angst, when Xion joins him. For some reason or another, she has her hood up. After a rather cryptic monologue, she takes off the hood... cut to Roxas, with a look of shock on his face. Xion continues talking, as we pan up to her face... and she looks just like Sora now, except for the voice. Then she steps off the clock tower into thin air, and turns around, hood up again, with only her eyes visible. Light starts flashing around her and she says, in Creepy Monotone, "You're next, Roxas. I have to make you a part of me too." Then the fight starts.
"Snarl of Memories" is perhaps one of the most infamous mind screws in the entire franchise, which is saying something. There are no proper ways to describe the cutscene, so this link will speak for itself.
"IT'S THERE... IT'S HUNGRY... DON'T TURN AROUND!!" is an inscription in one of the Twilight Town tunnels. It actually had nothing to do with the mission — it was randomly thrown in just for the sake of screwing with the players.
Not exactly; the sign could be referring to the first powerful Heartless you fight down there, or the Heartless in general. It is nonetheless unnerving.
Axel in this game embodies the childhood fear of a close friend and/or adult figure in your life turning out to be keeping secrets from you and not being at all what you thought they were. Before he became a genuine friend to Roxas and Xion, Axel was a ruthless, manipulative, sociopathic assassin, and his personal fears of losing Roxas and Xion combined with the worsening circumstances cause him revert to that way of life once more at Roxas and Xion's expense. Roxas' diary entries about how he doesn't even recognize Axel anymore just reinforce how chilling this whole situation is.
From Axel's point of view, his singleminded desire for Roxas and Xion to stay physically safe cause him to overlook their own personal wants, and in the end it tears apart their relationship. It's horrifying and tragic to imagine a situation where you do everything in your power to protect those you care about only to lose them.
This narration from the manga: In order to pretend that [Nobodies] have hearts like people, they act relying on their "memories" of their time as humans, but they don't actually feel anything.