Israeli officials on Tuesday slammed an EU directive that will bar all 28 member states from dealings with Jewish communities located beyond the 1949 Armistice lines, including eastern Jerusalem.
A high-ranking official, who requested anonymity, described the European Union's move as a disproportionate "attack" on Israel.
"When it comes to disputed territories, the Europeans prefer to attack a small country like Israel instead of taking on more powerful states, because they're afraid of retaliation."
Israel was "only informed of the directive at the last moment," he added.
The directive, due to be published on Friday and take effect from 2014, forbids EU member states from funding or dealing with Israeli communities in the Golan Heights, Judea, Samaria and eastern Jerusalem, according to reports.
It requires a clear distinction to be made in all signed agreements, between Israel and the territories it occupied in the 1967 Six Day War.
EU spokesman David Kriss told AFP: "These are guidelines on the eligibility of Israeli entities and their activity in the territories occupied by Israel since June 1967 for grants, prizes and financial instruments funded by the EU from 2014 onwards.
"It makes a distinction between Israel and the entities in the West Bank, east Jerusalem, the Gaza Strip and the Golan Heights," he said.
Israeli Deputy Foreign Minister Ze'ev Elkin told army radio the Europeans had made a "mistake" and that the directive would undermine any return to peace talks with the Palestinians.
"It's a very worrying initiative launched at a bad time, because it only reinforces the Palestinians' refusal to restart negotiations," he said.
Kriss said the EU wanted Israel to cooperate fully with the directive to ensure its "participation in projects between 2014 and 2020."
But Elkin told the Haaretz newspaper: "We are not ready to sign on this clause in our agreements with the European Union," but admitted that the refusal could "halt all cooperation in economics... (and) cause severe damage to Israel."
Palestinian leaders say they will only resume direct negotiations with Israel if they are held on the basis of the lines that existed before 1967, and if Israel freezes all settlement activity in Judea and Samaria.
Israel insists they must be held "without preconditions."
Yesterday, Communications Minister Gilad Erdan accused the Palestinian Authority for setting unreasonable preconditions to talks, claiming they were seeking to start talks "from the finish line."
The President of the Federation of Industrialists, Tzvika Oren, said Tuesday that he was “sorry to learn about the European Union's intention, to mix politics and economics.”
"The widespread network of economic connections between Israel and the EU states can be an instrument for advancing relations between us and the nations of the region, and the Palestinian Authority in particular,” he stated.
"Therefore, I call upon the EU Commission to act positively, to advance economic cooperation between Israel and the Palestinian Authority, which will help improve diplomatic relations in the region.
"I therefore call upon the European Union to refrain from creating blockages and taking steps that are likely to sabotage future agreements. Instead, we should concentrate on advancing a policy of dialogue and cooperation between Israel and the EU.”