Israel is retaliating for Thursday's United Nations vote on Palestinian statehood, announcing it will withhold $120 million in taxes and customs collected for the Palestinian Authority to pay debts to Israeli companies.
In a unanimous resolution passed Sunday, Israel's Cabinet said it would not negotiate on the basis of the UN General Assembly's recognition of a state of Palestine in the occupied West Bank, East Jerusalem and Gaza Strip.
"The unilateral step taken by the Palestinians at the United Nations violates peace agreements," Prime Minister Benjamin Netanyahu said, justifying Israel's rejection of the UN vote. The only way to Palestinian statehood and peace is through direct negotiations with Israel, he said.
Israeli Finance Minister Yuval Steinitz said the government would use the money it was to transfer to the Palestinians to pay off their debt to Israel's state-run electricity company and other Israeli firms.
The Cabinet also approved a plan to build 3,000 new homes for Jews in the occupied West Bank and East Jerusalem. Netanyahu said Israel would continue to build in response to the UN vote, which he described as an "attack on Zionism and the State of Israel."
Sunday's move came as cheering crowds welcomed Palestinian president Mahmoud Abbas back to the West Bank city of Ramallah following his diplomatic victory last week when the Palestinians won non-member state observer status at the UN General Assembly.
"The world said yes to the state of Palestine, yes to the freedom of Palestine, yes to the independence of Palestine, no to aggression, settlements and occupation," Abbas told some 5,000 people to wild applause.
The Palestinian president warned of "creative punishments" by Israel, referring to the latest settlement construction plans.
Friday's announcement of 3,000 new homes on Israeli-occupied land is especially contentious as building in the area near East Jerusalem known as E1 could obstruct the ultimate creation of a contiguous Palestinian state because it cuts through the West Bank.
The construction would connect the large Jewish settlement of Maale Adumim to Jerusalem, dividing the West Bank in two. The Palestinian cities of Ramallah and Bethlehem would be cut off from East Jerusalem.
U.S. Secretary of State Hillary Clinton said Saturday Israeli plans for new settlements abutting East Jerusalem "set back the cause of a negotiated peace." Britain and France urged Israel to rescind the decision, and other European states also denounced it.
Actual construction could be years away, if it takes place at all. Israeli Housing Minister Ariel Attias told Army Radio on Sunday, "There is no decision to build. There is a decision to plan. You can't build an apartment without planning."
Last week's UN vote was approved over fierce opposition from Israel and the United States.