Israeli Prime Minister Benjamin Netanyahu has told his ministers to stop high-level meetings with their Palestinian counterparts.
The order follows "Palestinians' violation of their commitments under peace talks", officials said.
It comes after a request by the Palestinians to join 15 UN treaties and conventions as a state party.
Correspondents say Mr Netanyahu's action has dealt another blow to the faltering US-brokered peace process.
The government officials said Israel's chief peace negotiator, Tzipi Livni, would be an exception from the PM's edict.
Defence and security officials will also be allowed to continue to engage with the Palestinians, according to reports.
Otherwise, only low-level co-operation will be permitted.
On Tuesday, the US Secretary of State, John Kerry, said the US would continue to promote the talks despite recent setbacks.
He blamed both sides for taking "unhelpful" steps.
The peace talks resumed in July under US auspices after a three-year hiatus.
Each side blames the other for violating previous promises.
The Palestinians were furious when Israel did not sanction the release of a fourth batch of prisoners, as agreed in principle under the terms on which the Palestinians returned to peace talks last year. The Palestinians wanted the group to include a number of Israeli Arab prisoners.
They were further angered when Israel reissued tenders for some 700 new settlement units in occupied East Jerusalem.
Israel captured East Jerusalem from Jordan in the 1967 Middle East war and formally annexed the area in 1980. Settlements built there and elsewhere in the occupied West Bank are considered illegal under international law, though Israel disputes this.
Israel stressed that it had predicated any prisoner release on progress being made in the negotiations and on the Palestinians abiding by a commitment not to seek membership of international agencies.
Cabinet members also said they would block a release unless the Palestinians agreed to extend the talks beyond 29 April, the date by which the US had said it had hoped to reach a full agreement.
However, the Palestinians said they would not agree to extend the talks unless the prisoners were freed and accused Israel of reneging on the deal.
Last week, Palestinian Authority President Mahmoud Abbas signed applications to join 15 international conventions which Palestinian officials said was a response to Israel's failure to release the prisoners.
Israel fears the Palestinians will use the treaties as a legal tool against it and to further enhance statehood which is subject to the negotiations.
Despite the acrimony, Mr Kerry said that neither side was abandoning the process.
"The truth is the parties say they want to continue these talks," he told the US Senate Foreign Relations Committee on Tuesday.
Correction 11 April 2014: This story has been amended to make clear that the tenders for settlement-construction in East Jerusalem were not new but had been reissued.