JERUSALEM — Israeli leaders on Tuesday condemned a European Union ban on funding to Israeli institutions that operate in occupied territories, but also acknowledged the country's growing isolation over its construction of Jewish settlements in the West Bank and east Jerusalem.
The EU decision marked a new international show of displeasure with Israeli settlements built on lands captured in the 1967 Mideast war, bolstering the Palestinian claim to these territories and animating an increasingly discordant Israeli debate over the wisdom of the settlement enterprise.
The move dominated Israeli newscasts throughout the day, and prompted Prime Minister Benjamin Netanyahu to summon senior Cabinet ministers for consultations.
"We will not accept any external edicts about our borders," Netanyahu said, adding that borders could only be resolved through direct negotiations with the Palestinians. He was suggesting that the settlements are aimed at bringing about changes in the pre-1967 borders, but not absorb the entire West Bank.
Netanyahu said the Europeans should deal with what he called "slightly more urgent" matters in the region, including the civil war in Syria and the Iranian nuclear program.
But Netanyahu's finance minister and senior coalition partner, Yair Lapid, warned that the move reflected Israel's deteriorating position on the global stage.
"The latest decision is part of a long line of decisions that are leading to Israel's isolation in the world. Time is not on our side, and every day that Israel is not in peace negotiations is a day in which our international standing is harmed more," he said.
Negotiations have been stalled for nearly five years, with Israeli settlement construction at the heart of the deadlock. U.S. Secretary of State John Kerry was in neighboring Jordan on Tuesday as part of an ongoing effort to bring the sides back together for talks.
The Palestinians have demanded that Israel halt construction in the West Bank and east Jerusalem, areas captured in 1967 that they claim for their future state, before negotiations can start. They also want Israel to accept its pre-1967 lines as the basis for a future border, with the possibility of small modifications reached in negotiations.
The Palestinians say continued settlement construction is a sign of bad faith and undermines hopes for dividing the land between two states. Well over 500,000 Israeli settlers now live in the West Bank and east Jerusalem, alongside some 2.5 million Palestinians.
Netanyahu says negotiations should begin without preconditions and has meanwhile allowed settlement construction to continue at a rapid pace.
The EU's move was just the latest indication of international displeasure with the settlements.
Last year, the United Nations General Assembly, over strong Israeli objections, recognized a Palestinian state along the 1967 borders and gave it upgraded observer status. President Barack Obama also has condemned settlement construction and said a Palestinian state should be established along the 1967 lines.
In a statement, the EU's mission to Israel said the new funding guidelines were approved on June 30. They will apply to "grants, prizes and financial instruments funded by the EU from 2014 onwards."
The EU issues dozens of grants, totaling millions of euros, to Israeli universities, companies and researchers each year. For example, the EU has contributed some 667,000 euros ($870,655) to help establish a center to reduce greenhouse emissions in Israel. Another program offers 950,000 euros ($1.2 million) to help improve veterinary inspections of livestock.
"The guidelines are ... in conformity with the EU's longstanding position that Israeli settlements are illegal under international law ... irrespective of their legal status under domestic Israeli law," the EU statement said.
"The purpose of these guidelines is to make a distinction between the state of Israel and the occupied territories when it comes to EU support," it added.
It said the move was a follow-up to a decision last December that "all agreements between the state of Israel and the European Union must unequivocally and explicitly indicate their inapplicability to the territories occupied by Israel in 1967."
For many Israelis, the decision was especially tough by grouping east Jerusalem with the West Bank. Israel annexed the area after the 1967 war and most Israelis, even those on the dovish left, consider it somehow distinct from the settlements and do not view its Jewish residents as settlers.
The decision puts Israel in a difficult situation: appear to agree that the occupied territories, including east Jerusalem and the annexed Golan Heights, are not part of Israel, or risk losing funding and collaboration opportunities provided by these EU programs.
Direct commercial ties are not affected by the order. But Europe, Israel's largest trade partner, also has begun to take action in that area.
The 28-member EU already bars goods produced in Israeli settlements from receiving customs exemptions given to Israeli goods. EU officials are currently considering measures that would more clearly label settlement goods.
Palestinian official Hanan Ashrawi welcomed the decision.
"The EU has moved from the level of statements, declarations and denunciations to effective policy decisions and concrete steps," she said. "The Israeli occupation must be held to account."
European officials tried to play down the significance of the measures. "This is not new. It's more of a clarification," said EU spokeswoman Maja Kocijancic. European officials estimated that less than 1 percent of funding actually goes to "settlement entities."
Nonetheless, Israeli officials reacted with great alarm and claimed the decision would undermine Kerry's efforts by encouraging the Palestinians to harden their positions.
Israeli Deputy Foreign Minister Zeev Elkin, one of the participants in the meeting with Netanyahu, called the EU decision a "very significant and worrying move" that would embolden the Palestinians in their "refusal to return to the negotiation table."
Other participants included chief peace negotiator Tzipi Livni, a relative dove who recently warned that Europe's shunning of the settlements could eventually lead to a wider boycott of Israeli goods if peace efforts do not resume.
Dani Dayan, an official with the Israeli settler movement Yesha, called the decision "one-sided and discriminatory" and said "the EU can no longer be perceived as neutral or objective."
Raffaella Del Sarto, who teaches at the European University Institute and SAIS Europe, Johns Hopkins University, said Israel appeared to be caught off guard by the EU's tough stance. "The EU is generally pretty good at declaring and not acting, and here we have the opposite development," she said. "Some would say that Israel is finding itself in growing isolation."
Earlier this week, a leftist Israeli newspaper columnist, Gideon Levy, crossed something of a rubicon in calling for an international boycott of Israel.
"As long as Israelis don't pay a price for the occupation ... they have no incentive to bring it to an end," he said.
Such a view is hardly mainstream, but it is also increasingly heard among Israelis who are despairing of a solution and who fear that the settlements will undermine Israel itself by making partition impossible and yielding, in effect, a bi-national state.