UK food labels are set to distinguish between goods from the Palestinians in occupied territories and produce from Israeli settlements.
The Food packaging guidelines advise a change from labels usually naming only Israel or West Bank as the source.
The government said it was opposed to a boycott of Israeli goods, but that the settlements posed an obstacle to peace.
The Palestinian general delegation to the UK welcomed the move, but Israel said it was "extremely disappointed".
All Jewish settlements in the West Bank are illegal under international law, though Israel disputes this.
The new guidelines recommend that food labels in supermarkets should bear the phrases "Israeli settlement produce" or "Palestinian produce".
Manuel Hassassian, Palestinian general Delegate to the UK, said: "We welcome this. We have been calling for this for two years, since we began lobbying major British supermarkets when we discovered that they were routinely selling products marked 'produce of the West Bank' which were in fact the produce of illegal settlements.
"This is a very positive response by the British government."
But the Israeli embassy said it was "extremely disappointed".
"We think this is singling out Israel and it plays into the hands of those who are calling for a boycott of Israeli goods," it said.
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