The Israeli ambassador has been summoned to the Foreign Office in protest at a decision to expand settlement building in the occupied West Bank and East Jerusalem.
Ambassador Daniel Taub was informed of "the depth of the UK's concerns" about the scheme to build 3,000 new homes in a meeting with Alistair Burt, the Minister for the Middle East. Following the meeting, the Foreign Office refused to rule out further moves against Israel.
"Any decision about any other measures the UK might take will depend on the outcome of our discussions with the Israeli government and with international partners including the US and European Union," a spokesman said.
The Foreign Office again urged the Israelis to drop the settlement plan announced by prime minister Benjamin Netanyahu. The spokesman said: "We deplore the recent Israeli government decision to build 3,000 new housing units and unfreeze development in the E1 block. This threatens the viability of the two-state solution."
Earlier, officials described Israeli press reports that Britain - together with France - was planning to recall its ambassador from Tel Aviv as "speculation". But a spokesman made clear that there would be a strong response if the plan went ahead.
"We have called on the Israeli government to reconsider. We have told the Israeli government that if they go ahead with their decision there will be a strong reaction," the spokesman said.
The announcement by Mr Netanyahu was widely seen as a reaction to last week's vote at the United Nations General Assembly recognising the Palestinians as a "non-member observer state".
Foreign Secretary William Hague joined US secretary of state Hillary Clinton in condemning the plan, describing it as "illegal" and saying it casts doubts on Israel's commitment to achieving peace.
Mr Hague had faced strong criticism at home for refusing to back the Palestinians' bid for enhanced recognition at the UN, with Britain instead choosing to abstain. He argued that it would simply antagonise the Israelis, making the prospects of achieving progress in the peace process even more remote.
The Israeli ambassador to Paris was also summoned to the French foreign ministry in protest at the settlement move, a foreign ministry spokesman said.