A dangerous confrontation was developing on Tuesday between the US and Iran after the Obama administration directly blamed the Iranian governnment for an alleged plot to blow up the Saudi ambassador and scores of others at a Washington restaurant with the help of a Mexican drug cartel.

The US attorney-general Eric Holder said Iran would be “held to account” over what he described as a flagrant abuse of international law. While the US says military action remains on the table, it is at present seeking instead to work through diplomatic and financial means to further isolate Iran.

The US Treasury department immediately imposed sanctions against five individuals allegedly linked to the plot.

The Iranian government reacted by dismissing the allegations, saying the US was expert at making false claims. “This is a fabrication,” said a spokesman for the Iranian president, Mahmoud Ahmadinejad.

Two men, one an an American-Iranian, Manssor Arbabsiar, 56, and Gholam Shakuri, an Iranian, have been charged in New York with the alleged “murder-for-hire” plot to pay a Mexican drug cartel to help assassinate Adel al-Jubeir, the Saudi ambassador and close confidante of the Saudi king.

According to the US justice department, the aim was to bomb a restaurant in Washington frequented by Jubeir with the possibility of a hundred or more bystanders being killed in the explosion. US officials said the Iranians put a $1.5m price tag on the assassination.

The White House said Obama called Jubeir today to express solidarity between the US and Saudi Arabia in the face of “a flagrant violation of US and international law”.

Arbabsiar appeared briefly in court in New York this afternoon, and was held without bail. Shakuri, who is alleged to be a member of the Quds Force, a special operations team inside the Iranian Revolutionary Guard is said by the US to be in Iran.

The US views the plot as state-sponsored terrorism. Secretary of state Hillary Clinton described it as a “violation of international norms” and said she would discuss with allies in Europe and elsewhere round the world how to further isolate Iran.

The Saudi embassy in Washington described the alleged attempt to assassinate its Jubeir as “despicable”.

Relations between the US and Iran have been tense for years over Tehran’s alleged pursuit of a nuclear bomb. But the court case heightens tensions even further, introducing unpredictable elements such a risk of retaliation by Saudi Arabia.

The central question is whether a rogue element in Iran may have been involved or whether the alleged plot had been sanctioned by a senior leader. Mike Rogers, the chairman of the House intelligence committee, who was briefed in detail, reufsed to say whether Ahmadinejad had been involved but he insisted it was “an Iranian government sanctioned event”.

Arbabsiar was arrested on September 29 at New York’s JFK airport following a sting operation involving the FBI and the Drug Enforcement Administration.

The FBI director, Robert Mueller, speaking alongside Holder at a press conference in Washington, described the plot as “reading like a Hollywood script”.

The justice department claimed Arbabsiar was working under the direction of the Iranian Revolutionary Guard.

He allegedly met on a number of occasions in Mexico with a DEA confidential source who was posing as a member of the drugs cartel Zetas. The source, according to the indictment, had faced drugs charges in the past but these had been dismissed in return for him becoming a paid informer.

According to the justice department, Arbabsiar met with the DEA source in Mexico on May 24 where he discussed explosives and explained that he was interested in, among other things, attacking an embassy of Saudi Arabia. They held further meetings in Mexico in June and July.

Arbabsiar allegedly arranged for $100,000 to the transferred into a bank account in the US for the supposed cartel member.

He is alleged to have told the DEA source that the assassination needed to go forward, despite possible mass casualties, telling him: “They want that guy [the ambassador] done [killed], if the hundred go with him f**k ‘em.” The agent and Arbabsiar allegedly discussed bombing a restaurant in the United States that the ambassador frequented.

When the agent noted that others could be killed in the attack, including US senators who dine at the restaurant, Arbabsiar allegedly dismissed these concerns as “no big deal”.

The use of a sting operation is likely to prompt scepticism about the extent, if any, of the Iranian government’s involvement. Although the focus of media attention this year has been on the Arab Spring, the Pentagon, State Department and White House have all been increasingly worried about alleged nuclear developments in Iran.

Steve Clemons, a Washington-based foreign affairs analyst, said:

“This is a serious situation - and this kind of assassination is the sort that could lead to an unexpected cascade of events that could draw the U.S. and other powers into a consequential conflagration in the Middle East.”

The five facing US Treasury sanctions are: Arbabsiar and Shakuri; Quds Force commander Qassem Suleimani; Hamed Abdollahi, a senior Quds Force official, who allegedly coordinated aspects of the plot; and Abdul Reza Shahlai, a Quds official also allegedly involved in the operation.