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Israeli officials on Tuesday slammed an EU directive that will bar all 28 member states from funding projects connected to Jewish settlements in the occupied territories, including annexed east 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," he said.
Israel was "only informed of the directive at the last moment," he added.
The guidelines, which were adopted by the European Commision on June 28 and are due to be published on Friday, will affect all EU grants, prizes and funding from 2014 onwards, with no further funding available to Israeli entities beyond the 1967 Green Line, a spokesman said.
The new rules require a clear distinction be made in all signed agreements between Israel and the territories it occupied in the 1967 Middle East war -- including the Golan Heights as well as the Gaza Strip and the West Bank including east Jerusalem.
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 Zeev 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.
Direct peace talks have been on hold for nearly three years, with the Palestinians refusing to return to the table 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 to resume talks, but without such "preconditions."
US Secretary of State John Kerry was due to arrive in Jordan later on Tuesday on his sixth visit to the region in as many months in his latest push to draw the sides back into direct talks.
Elkin said Israel was not ready to sign any agreements with the European Union which included the "territorial clause" which says that any funding would not apply to territories beyond the Green Line.
"We are not ready to sign on this clause in our agreements with the European Union," the deputy foreign minister told Haaretz newspaper, saying it could halt all cooperation in many fields and "cause severe damage to Israel."
Danny Dayan, a spokesman for the Yesha Settler Council, which represents Israelis living in the West Bank, strongly criticised the move.
"The one-sided and discriminatory EU directive means Europe has effectively decided to abandon any involvement it had in the Middle East peace process," he said in a statement.
"By aligning itself with the most extreme Palestinian demands... the EU can no longer be perceived as a neutral or objective," he added.
But senior 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," Hanan Ashrawi said in a statement.