The Trump administration has frozen $125 million in funding for the United Nations Relief and Works Agency, which provides aid to Palestinian refugees, according to three Western diplomats who were informed of the move. They said the funding, one third of the annual U.S. donations to the agency, was supposed to be transferred by Jan. 1 but was withheld.

Why it matters: A funding freeze could be seen as a slap against the organization — which the U.S. and Israel consider to be biased against Israel and too politicized — and an attempt to pressure the Palestinians to return to peace talks with Israel. But a State Department official said that the fact the money wasn't transferred on Jan. 1 doesn't mean it was frozen. "There are still deliberations taking place, and we have until mid January to decide what we are going to do,” the official said.

The details: The diplomats, who asked to speak on conditions of anonymity due to the sensitivity of the matter, said the funding was frozen until the Trump administration finishes its review of U.S. aid to the Palestinian Authority.

The move comes after the Palestinian Authority suspended their contacts with the Trump administration in response to its decision to recognize Jerusalem as the capital of Israel. A senior White House official said no decision have been made yet, but confirmed that a review of the U.S. assistance to the Palestinians is underway "in light of the Palestinians' recent conduct."

The diplomats added that U.S. officials told U.N. officials in the last two days that President Trump is considering totally cutting the part of the funding which was frozen, and is even considering cutting up to $180 million, which amounts to half of the U.S. funding to UNRWA.

The impact: The Western diplomats said freezing or cutting of such a big part of the U.S. funding would be catastrophic for the organization, would hamper its work and might lead to negative consequences for the Palestinian refugee camps in Gaza, the West Bank, Jordan and Lebanon.

U.N. secretary general António Guterres has spoken with senior U.S. official about the UNRWA funding and also consulted with foreign ministers from other donor countries, according to the diplomats.

The Israeli security establishment and the Coordinator of Government Activities in the Territories — the Israeli organization that oversees government activities in the West Bank and Gaza — are concerned about possible freezing or cutting of U.S. funding to UNRWA, fearing the escalation of the humanitarian crisis in Gaza.

“The humanitarian situation in Gaza is complicated enough and harming UNRWA funding will only make it more complicated," a senior Israeli security official told me.

What we're hearing: Prime Minister Benjamin Netanyahu is not enthusiastic about the cutting of U.S. funding to UNRWA, but is politically pressed by conservative ministers in his cabinet and by the fact he can't be more dovish on the Palestinian issue than President Trump.

Officials in the prime minister's office told diplomats from several western countries that Israel does not object to the cutting of U.S. funding to the Palestinian Authority, but prefers that the U.S. doesn't cut funding to UNRWA due to the fact it also serves Israeli security interests.

A senior Israeli official told me Netanyahu is in touch with the White House on the UNRWA funding issue, and conveyed the message that Israel prefers “gradual disengagement" with UNRWA by the U.S. and not a big funding cut.

The prime minister's office said in a statement: "Netanyahu supports President Trump's critical attitude towards UNRWA and believes practical steps need to be taken in order to change the fact that UNRWA is being used to entrench the Palestinian refugee problem instead of solving it."