Pro-Moscow separatists in eastern Ukraine were holding a group of European military observers in the city of Slavyansk on Friday night, claiming they had been travelling with a spy for the Kiev government.

The group was operating under the mandate of the Organisation for Security and Co-operation in Europe (OSCE) and comprised four Germans, a Pole, a Dane, a Swede and a Czech officer. According to the Ukrainian interior ministry, they were being escorted by five members of the Ukrainian armed forces when their bus was seized by separatists.

The ministry said it believed they were being held in the state security service (SBU) building in Slavyansk, which is being occupied by separatists led by a militant leader, Vyacheslav Ponomarev, who has declared himself the city's mayor.

Ponomarev told journalists: "It was reported to me that among them was an employee of the Kiev secret military staff … People who come here as observers for the European community bringing with them a real spy – that is inappropriate."

After the detention, the G7 nations announced new sanctions would be implemented against Russia, accusing Moscow of stoking tensions in eastern Ukraine with bellicose rhetoric and military manoeuvres on the border.

The new sanctions are expected take the form of an expansion in the list of prominent Russian individuals and companies accused of direct involvement in Moscow's intervention in Ukraine and subject to visa bans and asset freezes.

"Given the urgency of securing the opportunity for a successful and peaceful democratic vote next month in Ukraine's presidential elections, we have committed to act urgently to intensify targeted sanctions and measures to increase the costs of Russia's actions," a G7 statement said on Friday night.

The statement did not specify what new measures would be slapped on Moscow but it warned that "we continue to prepare to move to broader, coordinated sanctions, including sectoral measures should circumstances warrant".

At the same time, the leaders told Russia that "the door remains open to a diplomatic resolution of this crisis" and urged , on the basis of the Geneva accord. We urge Russia to join us in committing to that path. A senior US official said each G7 country would decide which targeted sanctions to implement and while the measures would be co-ordinated they would not necessarily be identical.

The White House said US sanctions could be levied as early as Monday.

An EU list targeting Russia with sanctions has been provisionally enlarged from 33 names to about 50 but it will only take effect once it has been approved by all member states. A foreign ministers' meeting is expected next week to debate the Ukraine crisis and make a final decision on the list.

The G7 sanctions decision came after a conference call between Barack Obama, David Cameron, François Hollande, Angela Merkel and Matteo Renzi. The US president is visiting Seoul.

"The leaders also agreed that Russia had not reciprocated – including by not publicly supporting the Geneva accord, nor calling on armed militant groups to lay down their arms and leave the government buildings they've occupied – and had in fact continued to escalate the situation through its increasingly concerning rhetoric and threatening military exercises on Ukraine's border," a White House statement said.

"The president noted that the United States is prepared to impose targeted sanctions to respond to Russia's latest actions."

Downing Street said the leaders had condemned "the absence of any efforts on the part of Russia to support the implementation of the Geneva agreement, and the further efforts to destabilise Ukraine".

The detained European observers were working for a small German-led military monitoring mission invited into the country by the Kiev government under an OSCE mandate. They report back directly to their national capitals, rather than to OSCE headquarters in Vienna.

Simon Ostrovsky, an American journalist from Vice News who was detained for four days in the same building as the monitors, gave a grim account of conditions. "On Monday night I was pulled out of a car at a checkpoint, then blindfolded, beaten, and tied up with tape. After spending hours alone on the floor of a damp cell with my hands tied behind my back and a hat pulled over my eyes, I was led into a room where I was accused of working for the CIA, FBI and Right Sector, the Ukrainian ultranationalist group," he wrote. "When I refused to give the password to my laptop, I was smacked in the arm with a truncheon. When I was asleep on the floor, masked men came to wake me up and tell me how no one would miss me if I died, and then kicked me in the ribs as they left."

He said he saw a dozen other detainees in the cellar, including Artyom Deyneha, a local computer programmer, Serhiy Lefter, a freelance journalist and Vadim Sukhonos, a deputy in the city council.

Ukraine announced it was launching the second phase of its "anti-terrorist operation" in the east of the country, designed to squeeze out separatist rebels from Slavyansk. The interior minister, Arsen Avakov, denied claims he had suspended the operation on Thursday because of the growing threat of Russian invasion.

A column of Ukrainian armoured vehicles flattened several checkpoints on the outskirts of the town, only to retreat. Avakov said on Facebook his troops had shown restraint in order to minimise risks to the "peaceful population".

Ukrainian officials said the latest operation was designed to encircle Slavyansk, the de facto rebel capital, controlled by heavily-armed pro-Russian gunmen. They said the "terrorists" inside the town – with a population of 120,000 – had hidden themselves in kindergartens and hospitals. Ukrainian forces would not try to weed them out because of the obvious risk of civilian casualties, they said.

There were few signs, however, that this blockade was real. Ukrainian forces maintained a checkpoint, set up on Thursday, some six miles east of the town, along a forest road. Several buses carrying troops arrived to the north. But there was no Ukrainian army presence on the main route between Donetsk, the regional capital, and Slavyansk. The separatists remained dug in at a key southern entrance over a bridge, as well as other entry points.

The body of a second person found tortured near Slavyansk was identified on Friday as Yuriy Popravko, a 19-year-old Kiev student and Maidan activist. He was found dumped next to Vladimir Rybak, a city councillor from the town of Horlivka, and a prominent opponent of separatism. Rybak was abducted shortly after trying to push his way into Horlivka city hall and remove the "Donetsk People's Republic" flag. Kiev says it has intercepts showing that Slavyansk's self-appointed mayor Vyacheslav Ponomarev was involved in Rybak's murder.

Popravko disappeared on 16 April, after apparently travelling to Kharkiv in the east of Ukraine to see his girlfriend. According to Vesti newspaper, his relatives are trying to retrieve his body from Slavyansk's pro-Russian militia, so far without success. Gruesome photos circulating on the internet show that Rybak and Popravko were tortured then drowned.

On Friday, meanwhile, at an airfield in Kramatorsk, 9 miles away, a Ukrainian military helicopter caught fire. Pro-Russian militants issued a statement saying they had shot it. Black and grey smoke billowed above the base, recaptured by Ukrainian forces last week. Defence officials in Kiev confirmed that a sniper had hit the fuel-tank, causing the Mi-8 helicopter to explode. The pilot managed to escape, they said.