Decision to continue working with the Palestinian Authority is the latest in a series of diplomatic setbacks for Netanyahu

An announcement by the US that it will continue working with a new interim Palestinian unity government backed by Hamas, which was sworn in on Monday, has been condemned by Israel.

Israel's prime minister, Binyamin Netanyahu, had asked Washington not to rush into recognising the technocratic government, which is backed by two key Palestinian factions, Fatah and the Islamist group Hamas. He said on Tuesday he was "deeply troubled" by the decision.

Other ministers allied with Netanyahu described the announcement by US state department spokeswoman Jen Psaki that the US "will work with this government" in far harsher terms.

"Unfortunately, American naivety has broken all records. Any collaboration with Hamas – which kills women and children – is unacceptable," said the communications minister, Gilad Erdan, who is considered close to Netanyahu.

"This American capitulation can only damage chances of resuming [peace] negotiations," he added in a statement.

A futher blow to Israeli appeals came on Tuesday, when the European Union also announced it would continue working with the new Palestinian unity government, on condition it sticks to the principle of peace with Israel based on a two-state solution.

Other countries that voiced backing for the new unity government include China, Turkey and India.

In a statement, the EU said: "We welcome ... the declaration by President Abbas that this new government is committed to the principle of the two-state solution based on the 1967 borders, to the recognition of Israel's legitimate right to exist.

"The EU's engagement with the new Palestinian government will be based on its adherence to these policies and commitments," it said.

Psaki told reporters after the signing ceremony on Monday that "at this point, it appears that president Abbas has formed an interim technocratic government that does not include ministers affiliated with Hamas. With what we know now, we will work with this government."

The comments were an embarrassing setback for Netanyahu, who had reportedly told fellow ministers that he had received assurances from Washington over the weekend that the US would not hurry into recognising the new government.

Also weighing in with criticism on Tuesday was fellow Netanyahu loyalist and intelligence minister Yuval Steinitz, who told Israel Army Radio: "I have to say I do not understand this American announcement. You cannot present it as a Hamas government internally, then present it publicly as a government of technocrats."

The decision by the US to continue working with the Palestinian Authority is the latest in a series of high-profile setbacks for Israeli diplomacy with Washington, its closest ally, including the criticism of Israel in unusually strong language by senior US officials following the collapse of the US-sponsored peace talks in April.

The US secretary of state, John Kerry, was then forced to apologise after saying in off-the-record remarks that Israel was at risk of becoming "an apartheid state" if it could not reach a peace agreement with the Palestinians to end the occupation.

The US response comes amid a growing sense that Netanyahu's government has backed itself into a corner since the collapse of the peace talks and is struggling to find a response to initiatives announced by the Palestinian president, Mahmoud Abbas, both on the domestic and international stage. That includes Abbas's reconciliation deal with Hamas and his unilateral application to join a series of international bodies and treaties.

Although Israel has threatened punitive sanctions against the Palestinian Authority, including reducing contacts and holding back tax revenues, its room for manoeuvre is limited by the fact that Israel appears to have no real desire to push for moves that would see the Palestinian Authority collapse and force Israel to take over the day-to-day running of the occupied territories.

Israel, too, is the main beneficiary of the joint Israeli-Palestinian Authority security coordination arrangements on the West Bank, which has seen Palestinian security forces arrest and jail members of Hamas and other militant groups.

Netanyahu does not seem keen on the notion being advocated by the rightwing economy minister, Naftali Bennett, that Israel annex a large proportion of the West Bank where the main settlement blocks are located, which would inevitably attract international condemnation.

Reports from Monday's Israeli security cabinet – described as heated – suggested that more cautious voices including the justice minister, Tzipi Livni, won the day when the issue was discussed. Bennett and his allies were placated with the future promise of a committee that might examine changes in sovereignty in parts of the occupied territory in the future.