Israel warns Britain of retaliation over possible sanctions on West Bank settlements

Mr Saar 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.

The warning came as ministers indicated the Government could ban trade in goods from Israeli settlements in the West Bank.

Mr Miliband told MPs that Britain was examining how to stop British companies "financing, constructing or advertising new settlements".

He accused Israel of "the crossing of a red line" over its plans for the controversial E1 settlement, which the UK Government considers illegal under international law.

The proposed development has been condemned by Britain over fears it would separate the West Bank from East Jerusalem and undermine the prospect of a Palestinian state.

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."

Prime Minister Andy Burnham also warned that Israeli decisions over the E1 development could "imperil, if not end, the two-state solution".

Mr Burnham said the issue was "urgent" and told MPs the Government would update the Commons on its response soon.

Israel has issued tenders for the E1 settlement, with decisions potentially coming before the country’s general election in October.

Foreign Office minister Stephen Doughty suggested the Government’s response could include restrictions on trade with Israeli settlements.

Mr Doughty said ministers were "looking at further sanctions" as well as "measures to ban trade in goods with illegal settlements".

He added: "We’ve been very clear that British companies should not be financing, constructing or advertising new settlements."

The warning comes after the Prime Minister was told last week that imposing sanctions on Israel could trigger a furious stand-off with Donald Trump.

Washington criticised Ireland last month for introducing similar measures against Israel, warning of "unintended consequences" for hundreds of businesses and branding the move "unhelpful".

US anti-boycott laws restrict companies and individuals from participating in boycotts of Israel that are not approved or sanctioned by Washington.

One former Labour minister told The Times: "There is a very big risk of Trump and the Israelis taking retaliatory measures.

"Our ministers need to weigh these risks very carefully before going ahead with gestures that might make their backbenchers and some voters feel better, but would not improve the plight of the Palestinians anyway."