The US has suspended all road journeys by its diplomats in Iraq outside Baghdad's heavily fortified Green Zone.
The Green Zone is the administrative centre of Baghdad
This follows an incident in which 11 Iraqi civilians died when security guards from the US firm Blackwater opened fire in a busy Baghdad square.
Blackwater, which says its guards acted only in self-defence, has a contract to provide security to all US state department employees in Iraq.
Iraqi PM Nouri Maliki has called on the US authorities to replace the firm.
"This crime has generated a lot of hatred in the government and the people against Blackwater," Mr Maliki said, the AFP news agency reported.
"For their own interests, the Americans should hire a new company to protect their people so they can move freely."
Mr Maliki again disputed Blackwater's account of the incident. He said he would not tolerate the "killing of our citizens in cold blood".
The prime minister said the Sunday's shooting was "the seventh of its kind" involving Blackwater.
The company has had all its operations in the country suspended by the Iraqi government.
The Iraqi interior ministry has said the men fired randomly at civilians in a crowded square in the capital in Sunday's incident, killing 10 innocent bystanders and a policeman.
On Tuesday, the US Secretary of State, Condoleezza Rice, telephoned Mr Maliki to express her regret over the deaths and pledge to help carry out a "fair and transparent" investigation into the incident.
In a statement sent to US citizens in Iraq on Wednesday, the US embassy said it had suspended all road journeys by its diplomats throughout the country in order to conduct a safety review.
BLACKWATER USA FACTS
Founded in 1997 by a former US Navy Seal
Headquarters in North Carolina
One of at least 28 private security companies in Iraq
Employs 744 US citizens, 231 third-country nationals, and 12 Iraqis to protect US state department in Iraq
Provided protection for former CPA head Paul Bremer
Four employees killed by mob in Falluja in March 2004
"This suspension is in effect in order to assess mission security and procedures, as well as a possible increased threat to personnel travelling with security details outside the [Green Zone]," it said.
The BBC's Hugh Sykes in Baghdad says the state department will also have taken into account the increased danger for Blackwater employees if they continue to operate in Iraq.
Last week, the US ambassador to Iraq, Ryan Crocker, spoke of the importance of private security contractors in Iraq and our correspondent says it will now be very difficult for some US diplomats to conduct their normal business.
The ban is expected mainly to affect those state department personnel involved in reconstruction projects, but it may also restrict contact with the Iraqi foreign ministry, which is based outside the Green Zone.
'Safest place in Iraq'
Baghdad's Green Zone - officially the International Zone - is a heavily fortified area of closed-off streets in central Baghdad where most Iraqi government offices and the US embassy are located.
This area of about 10 sq km is supposed to be the most secure place in the country, although it has still been a frequent target of insurgent attacks.
Its land-based perimeter is surrounded by concrete blast walls - designed to stop suicide bombers penetrating the nerve centres of official power. The River Tigris acts as a natural defensive barrier along its remaining circumference.
Iraqis often see it as a US-controlled bubble squatting inconveniently in the middle of Baghdad, disrupting life for those on the outside and cushioning those inside from the everyday realities of life in Iraq.