The decision came one day after Hamas took control of the Palestinian parliament following its victory in a general election on 25 January.
Israeli public radio said the cabinet approved a halt to monthly transfers of tens of millions of dollars in customs duties that Israel collects on behalf of the Palestinian Authority.
The cabinet also called on the international community to withhold most aid to the Palestinian Authority, but said humanitarian assistance should continue.
Hamas today officially nominated Ismail Haniyah as its candidate for the next Palestinian prime minister.
(compiled from agency reports)