Europe stand-off escalates over new settlements

Western states including Britain were locked in an escalating diplomatic confrontation with Israel last night over plans by Benjamin Netanyahu's government to build a large-scale settlement amid Palestinian areas.

The Israeli envoys to France, Spain and Sweden, as well as Britain, were warned that going ahead with the project could jeopardise the peace process and erode Western support for the Jewish state. The UK is also said to be considering cancelling some trade deals and, while reports that the UK and France may withdraw their own ambassadors were played down, officials in London and Paris maintained that the option was on the table.

The settlement plan was presented in Israel as a reaction to Fatah's successful bid for recognition by the United Nation's general assembly as a "non-member observer state" last week. But the construction of 3,000 homes, particularly in the E1 area, north-east of Jerusalem, would effectively bisect the West Bank and further damage Palestinian aspirations of sharing the city in a future two-state solution.

There is anger that Israel has ignored the West's repeated requests not to go ahead with the settlement plans despite being given widespread support during its offensive in Gaza. Furthermore, senior diplomats say, the Israelis were fully aware that the backing for Hamas had risen after its rockets hit Tel Aviv and a district of Jerusalem – at the expense of the Palestinian Authority head Mahmoud Abbas – and going ahead with the construction would further undermine him and the organisation.

The Israelis were already withholding £75m needed by the Palestinian Authority to pay civil servants with the Israeli finance minister, Yuval Steinitz, openly stating this was in retaliation for the UN move.

The Foreign Office minister Alistair Burt said yesterday: "This morning I met Israeli ambassador to the UK, Daniel Taub, who was formally summoned to the Foreign Office…following the Israeli decisions to build 3,000 new housing units in East Jerusalem and the West Bank, to unfreeze planning in the area known as E1 and to withhold tax revenue from the Palestinian Authority. I set out the depth of the UK's concern about these decisions and I called on the Israeli government to reverse them."

Israel, however, remained unrepentant. Mr Steinitz said his government could not have remained indifferent to the Palestinians' unilateral move at the UN.

The settlement plan had already been condemned by US Secretary of State Hillary Clinton. The UN Secretary-General Ban Ki-moon said it would be "an almost fatal blow" to peace.