Israel has warned it will retaliate if the UK imposes sanctions because of its plans to expand settlements in the West Bank.
Foreign Secretary Ed Miliband on Tuesday said the UK would “reset” its policy on Israel in the coming weeks.
A minister in his department suggested goods coming out of Israeli settlements in the West Bank could be subject to sanctions.
Mr Miliband’s Israeli counterpart Gideon Saar said his country’s government was likely to act in response to UK sanctions.
He said: “If Britain acts against Israel, Israel will act against Britain.”
“If they act, I think they will be making a big mistake,” the Israeli foreign minister told a Hebrew language news site.
Prime Minister Andy Burnham has warned that Israeli decisions over a controversial settlement could “end” the prospect of a two-state solution with Palestine.
Mr Burnham told the Commons he was concerned about Israel’s statements on the E1 settlement in recent weeks.
He said if decisions about it are brought forward by Israeli Prime Minister Benjamin Netanyahu ahead of October’s general election, it could “imperil or end” the two-state solution in the Middle East.
Israel has issued tenders for the E1 settlement, which the UK Government has condemned as illegal under international law.
The UK has criticised the E1 plans as they would separate the West Bank from East Jerusalem.
Speaking in response to a question from Labour MP Debbie Abrahams (Oldham East and Saddleworth) in the Commons, Mr Burnham said: “We’ve seen the really quite worrying statement about the E1 extension and the settlements there, and the fast-track tender process, which I think will lead to decisions being made before the Israeli election.
“Which, as I understand it, could imperil, if not end, the two-state solution. So these matters are urgent. They do need to be confronted, and I believe we will be updating the House soon on those matters.”
Mr Miliband earlier said the Government is looking at how to stop British companies “financing, constructing or advertising new settlements” in the West Bank.
Speaking during Foreign Office questions, he branded it “the crossing of a red line, as it cuts through the heart of the West Bank and risks making a Palestinian state unviable”.
Mr Miliband said: “This Government will not acquiesce in the destruction of the two-state solution.
“We will act, and I will set out a comprehensive set of measures in the coming weeks.”
He added: “We need a comprehensive reset of our policy across the piece.
“Many members of the House on both sides have made very, very important points, not just about trade, but a whole set of issues, including around the ICJ (International Court of Justice) judgment on legality.
“I want a comprehensive reset of our approach on these issues because it is necessary, it is high time.”
Foreign Office minister Stephen Doughty meanwhile indicated the policy reset could include a ban on trade with illegal Israeli settlements in the West Bank.
Mr Doughty said: “We have absolutely condemned the settler violence, the settler terrorism that we have seen, absolutely our condemnation of the proposals for E1 and all illegal settlements, and indeed we have joined other countries around the world in condemning this proposal and been very, very clear with the government of Israel that this must stop.
“The Prime Minister has been very clear that we need to do more, including looking at further sanctions, both those involved in the violence in Gaza, but also looking at measures to ban trade in goods with illegal settlements.
“We’ve been very clear that British companies should not be financing, constructing or advertising new settlements.”
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