The UK government said it will retain its presence in East Jerusalem as Israel insisted the British consulate in the city had "ceased to function".
Israel's foreign affairs minister Gideon Sa'ar said the British consulate was "ending its operations" in East Jerusalem today.
But Foreign Secretary Ed Miliband insisted the building would stay open as the "UK Mission, Jerusalem".
The Israeli government's comments followed a UK ban on trade with illegal West Bank settlements announced last month.
The UK had accused his government of turning a blind eye to the "ethnic cleansing" of Palestinians, which he described as "false accusations against Israel".
Mr Sa'ar said the consulate "ceased its functions", with the consul general and 20 diplomats departing Israel, leaving just seven diplomats.
In response, the UK insisted it was withdrawing staff "to ensure their safety".
Mr Miliband said the UK has made it clear that "we do not accept that the government of Israel has the legal right to close the British Consulate General in Jerusalem, which has been there for nearly 200 years.
"The UK government reiterates its long-standing view that East Jerusalem is occupied territory.
"Following discussions with the government of Israel, our Consulate General building will not be closing, and will be known as the UK Mission, Jerusalem from today. The UK Mission, Jerusalem is independent, operational, and will continue to deliver vital services and our work with the Palestinian people.
"This will ensure that we maintain our long-standing British presence and the UK's role in support of the two-state solution.
"Without an understanding, we would not have the necessary assurances for the security and protections of our staff and premises. Accordingly, the UK has temporarily withdrawn a number of staff and families to ensure their safety and security.
"We will work in the coming months to build back up our presence, and we will not take reciprocal action while such discussions are under way and credible.
"The UK stands steadfast by the measures we took on 8 September, in concert with the international community, in support of a two-state solution to deliver peace and security for the people of Israel and Palestine."
Mr Miliband was referring to remarks he made in the House of Commons that a "new approach" was necessary because plans for West Bank development would render a two-state solution "unviable".
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He said: "The British government agrees that there is ethnic cleansing of Palestinians in areas of the West Bank - perpetrated by settler terrorists.
"And all too often the Israeli government has turned a blind eye to this and worse, members of it have made statements and taken actions to support the forced displacement of Palestinians."
Sky's Middle East correspondent, Adam Parsons, in Jerusalem, described the consulate as "to all intents and purposes, Britain's embassy with the Palestinians".
The change to 'UK Mission' was, he said, a "stop-gap" move aimed at kicking the issue into the long grass while the two sides tried to find a diplomatic solution.
Adam's full report is available at the top of this page.
Both Israel and the US criticised the UK's stance, which involves a ban on imports from illegal settlements in the West Bank and sanctions on individuals and firms providing services to settlers.
Overnight, workers in Jerusalem were seen removing signs and plaques at the consulate.
Reuters journalists saw workers in the consulate remove a plaque reading "British Consulate General" and another sign for its consular section.
(c) Sky News 2026: British consulate in Jerusalem to become 'UK Mission' as diplom

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