The Israeli government has declared the Gaza Strip a "hostile entity" in response to the continued rocket attacks by Palestinian militants there.
Qassam rockets are frequently fired from Gaza into southern Israel
Israeli officials told the BBC fuel and electricity supplies could be targeted, but not water, food or medicine.
The militant group Hamas, which controls Gaza, said such a move would be considered a declaration of war.
In Jerusalem, US Secretary of State Condoleezza Rice also said the US considered Hamas a "hostile entity".
But she added that the US "would not abandon the innocent Palestinians" of Gaza.
Ms Rice arrived in Jerusalem on Wednesday for talks about re-starting the Middle East peace process.
Israeli public pressure for retaliation has grown since a rocket fired from Gaza hit an army base last Tuesday, injuring 69 troops.
Palestinian militant groups say the rocket fire is a response to Israeli military action in Gaza and the West Bank.
Israeli Prime Minister Ehud Olmert's office said his security cabinet had approved the "hostile entity" classification on Wednesday morning.
"Additional restrictions will be imposed on the Hamas regime, limiting the transfer of goods to the Gaza Strip, cutting back fuel and electricity, and restricting the movement of people," a statement said.
It said the sanctions would be implemented "following a legal review" to examine the legal and humanitarian consequences.
Israeli officials reportedly hope the new measures will put pressure on Hamas, which ousted its rivals Fatah to seize control of Gaza in June, to halt rocket attacks on southern Israel.
A spokesman for Hamas in Gaza, Fawzi Barhoum, condemned the decision.
"It is a declaration of war and continues the criminal, terrorist Zionist actions against our people," he said.
"They aim to starve our people and force them to accept humiliating formulas that could emerge from the so-called November peace conference," he added, referring to the US-sponsored talks expected later this year.
The Palestinian Information Minister, Riyad al-Malki, said the Palestinian Authority would ask the US to "pressure Israel to refrain from taking such action".
Correspondents say that by formally declaring Gaza "hostile", Israel could argue that it is no longer bound by international law governing the administration of occupied territory to supply utilities to its 1.5 million inhabitants.
But the current position is that, under international law, Israel remains legally responsible for the coastal strip, despite withdrawing two years ago, because it still controls Gaza's borders, airspace and territorial waters.
An Israeli government source told the BBC that Israel believed the decision was entirely legal in terms of Israeli law, which Israelis "correlate with international law".
But UN Secretary General Ban Ki-moon urged Israel to reconsider its decision.
"Such a step would be contrary to Israel's obligations towards the civilian population [of Gaza] under international humanitarian and human rights law," he said.
The Israeli move will only be seen by Palestinians as a form of collective punishment and risks consolidating support for Hamas in Gaza, BBC diplomatic correspondent Jonathan Marcus says.
Ms Rice is in the Middle East for talks ahead of the peace conference.
The US is supporting Mahmoud Abbas while isolating Hamas
She is due to meet Mr Olmert and the Palestinian Authority President Mahmoud Abbas.
With US encouragement, the two recently held a series of face-to-face meetings.
After their last meeting on 10 September, both leaders reaffirmed their commitment to a two-state solution and agreed to set up negotiating teams to discuss some of the disputed issues.