Israeli officials on Tuesday lashed out at the EU over guidelines barring its 28 member states from funding projects in Jewish settlements, including annexed east Jerusalem.
The guidelines were adopted by the European Commission on June 28 and will affect all EU grants, prizes and funding from 2014 onwards, with no further funding available to Israeli entities beyond the 1967 Green Line, officials said.
The move infuriated Israel, with a high-ranking official describing it as an "attack" on the Jewish state, while the Palestinians welcomed it.
"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," the Israeli official said.
Israel, he said, had only been informed about the move "at the last moment."
Palestinian official Hanan Ashrawi welcomed the move.
"The EU has moved to... concrete steps which constitute a qualitative shift that will have a positive impact on the chances of peace," she said.
The guidelines will be formally published on Friday.
They require that in all signed agreements with Brussels a clear distinction be made between Israel and the territories it occupied in the 1967 Six-Day war -- the Golan Heights, the Gaza Strip and the West Bank including Arab east Jerusalem.
"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," EU spokesman David Kriss told AFP.
"It makes a distinction between Israel and the entities in the West Bank, east Jerusalem, the Gaza Strip and the Golan Heights," he said.
The aspect which has most angered Israel is the "territorial eligibility" clause which means that from 2014, only territories within the 1967 borders will be considered eligible for any EU funding.
"This is the first time such an official, explicit directive has been published by the European Union bodies," a senior Israeli official told Haaretz newspaper.
He described the move as an "earthquake" with both practical and political significance.
"Until today there were understandings and quiet agreements that the EU does not work beyond the Green Line; now this has become a formal, binding policy.
"From now on, if the Israeli government wants to sign agreements with the European Union or one of its member states, it will have to recognise in writing that the West Bank settlements are not part of Israel," he said.
But a spokeswoman for EU foreign policy chief Catherine Ashton said there had been no change in policy.
"It's not a new approach," Maja Kocijancic told a news briefing in Brussels, adding the guidelines would "bring clarity into this system".
Deputy Foreign Minister Zeev Elkin told Haaretz that Israel would not sign any agreements containing such wording.
"We are not ready to sign on this clause in our agreements with the European Union," he said, suggesting it could halt Israel-EU cooperation in many fields and "cause severe damage to Israel".
Defence Minister Moshe Yaalon said regardless of the EU's position, Israel would continue to treat the West Bank according to what it saw as its own vital interests.
"It is not new that many countries around the world refer to Judaea and Samaria as occupied territory and they act accordingly," he told reporters during a visit to northern Israel, using the biblical term for the West Bank.
"We have our policy concerning Judaea and Samaria and we shall continue to act according to our policy and our interests," he said.
Direct Israeli-Palestinian peace talks have been on hold for nearly three years, with the Palestinians refusing to negotiate without a freeze on settlement activity and Israel's acceptance of the 1967 lines as the basis for final status negotiations.
Israel says it wants talks, but without any such "preconditions".
As the news emerged, US Secretary of State John Kerry arrived in Jordan for his sixth Middle East visit in as many months as he pushes for a resumption of Israeli-Palestinian peace talks.
Danny Dayan, a spokesman for the Yesha Settler Council which represents Israelis living in the West Bank, described the EU move as "one-sided and discriminatory".
He said it meant Europe had "effectively decided to abandon any involvement it had in the Middle East peace process".
"By aligning itself with the most extreme Palestinian demands... the EU can no longer be perceived as a neutral or objective," he added.