Israel has broken off Middle East peace talks and brought the US-brokered process to the brink of collapse.
The move came in protest at a reconciliation agreement between the Western-backed Palestinian Authority and the militant group Hamas, the Jewish state's sworn enemy.
Israel's Security Cabinet made the decision during a marathon emergency meeting convened to discuss the new Palestinian deal. The rival Palestinian factions Hamas and Fatah announced the reconciliation plan yesterday, meant to end a seven-year rift.
Israel objects to any participation in Palestinian politics by Hamas, which has killed hundreds of Israelis in suicide bombings and other attacks over the past two decades.
In a statement issued by Prime Minister Benjamin Netanyahu's office, the government said it would not hold negotiations with a government "backed by Hamas".
"Instead of choosing peace, Abu Mazen formed an alliance with a murderous terrorist organisation that calls for the destruction of Israel," the statement said, referring to a name Palestinian president Mahmoud Abbas is also known by.
The statement said Israel also would respond to Mr Abbas' recent decision to join 15 international conventions "with a series of steps," language that typically refers to financial sanctions against the Palestinians.
Despite Israel's decision, State Department spokeswoman Jen Psaki refused to declare the negotiations over and said the US is "still making the effort".
Even with the tough stance, Mr Netanyahu left the door open to salvaging negotiations, which are set to expire next Tuesday.
"He still has the opportunity to reverse course, to go to the right direction, to abandon this pact with Hamas," Mr Netanyahu told US broadcaster NBC. "I hope he does it. Because if we encounter a Palestinian leadership and a Palestinian government that is ready to pursue genuine peace negotiations, we're going to be there."
Israel transfers about 100 million dollars (£60m) in tax and customs money to the Palestinians each month. It has withheld these funds in the past as a punitive measure, money needed to keep Mr Abbas' self-rule government afloat.
Mr Abbas won assurances in recent Arab League meetings that Arab countries would pay the same amount to the Palestinian Authority if Israel freezes the transfers. However, some of the Arab donor countries have in the past not met their aid commitments.
Saeb Erekat, the chief Palestinian peace negotiator, said Palestinian reconciliation is an internal matter.
"Israel had no right to interfere in this issue," he said. He condemned any possible Israeli sanctions as "piracy", saying the tax revenues are Palestinian money.
For Secretary of State John Kerry, the Israeli decision was the latest - and perhaps final - blow to the peace efforts he has led for the past nine months.
With great expectations, Mr Kerry persuaded the sides to resume peace talks last July after a nearly five-year break.
Initially, he hoped to forge a comprehensive peace deal ending decades of conflict. But after months of fruitless efforts, Mr Kerry scaled back his goals and said he would seek a preliminary "framework" agreement by April, with the goal of extending talks to hammer out the final details.
Despite more than 10 visits to the region, and numerous phone calls with the Israeli and Palestinian leaders, Mr Kerry had to abandon even that more modest goal for simply seeking a way to extend talks.
From the beginning, the negotiations never seemed to get off the ground, frequently devolving into excuses and finger pointing.
The Palestinians - and Mr Kerry - questioned Israel's commitment to peace when it continued to build settlements in the West Bank and east Jerusalem throughout the talks. The Palestinians claim both areas, along with the Gaza Strip, for a future state. Israel captured all three areas in the 1967 war.
The Palestinians also accused Israel of never presenting a formal peace proposal during the months of meetings.
Israel, meanwhile, accused the Palestinians of intransigence and holding extremist positions. In particular, Mr Netanyahu criticised the Palestinians for refusing to recognise Israel as the Jewish homeland. Mr Abbas said such an endorsement would hurt the rights of Palestinian refugees and Israel's Arab minority.
The talks, already strained, hit a downturn late last month after Israel failed to carry out a fourth and final release of long-serving Palestinian prisoners it had promised at the outset of the talks.
The Palestinians responded by renewing their campaign for international recognition of the "state of Palestine" in international bodies. The Palestinians joined 15 international treaties, triggering Israeli objections that they were bypassing peace negotiations.