Israel blamed the Hamas-led Palestinian government today for a Tel Aviv suicide bombing that killed nine people at a sandwich bar.
However, acting Prime Minister Ehud Olmert decided against launching a military offensive against it.
After a meeting of the interim cabinet and security chiefs, Mr Olmert's office said Israel would instead revoke the Israeli residency status of Hamas officials living in East Jerusalem, which means they could be subject to arrest if they enter the city.
The cabinet also approved a police crackdown on the smuggling of Palestinians without permits, who could be militants, into the Jewish state. "Olmert heard the defence establishment's ideas for possible strikes against the Palestinian Authority and, though the government is responsible, the decision was that there should be more limited action for now," a political source said.
Us President George W. Bush, asked if he was encouraging Israel to show restraint, said: "I have consistently reminded all parties that they must be mindful of whatever actions they take and mindful of the consequences."
A large-scale Israeli assault targeting the new Palestinian government could spark a backlash against the Jewish state at a time when it is trying to cement a US-led boycott of the Islamic militant group.
Hamas, which has largely abided by a year-long truce but refuses to embrace peacemaking efforts, stirred Israeli and Western ire by describing yesterday's attack - claimed by the militant group Islamic Jihad - as an act of "self defence".
Today, Prime Minister and senior Hamas leader Ismail Haniyeh said Israeli actions had triggered the attack. "The reason behind this cycle is the continuation of the occupation and the continued Israeli assaults against the Palestinian people," Mr Haniyeh said before a cabinet meeting.
It was the first such bombing in Israel since Hamas took power three weeks ago, and the deadliest since 2004.
In a statement, a top Islamic Jihad official vowed more suicide bombings, saying the group had 70 more "martyrs-in-waiting" who were "awaiting the moment to explode".
The moderate Palestinian President Mahmoud Abbas condemned the Tel Aviv bombing, angering militants who demanded on Tuesday that he apologise.
In response, Mr Abbas issued a fresh critique of the attack as an act of a type that "distort the image of the struggle of the Palestinian people and their just goals" and said he objected to killing civilians on either side of the conflict.