Britain is on the brink of a diplomatic crisis with Russia which could see the expulsion of several diplomats from London and tit-for-tat reprisals by Moscow. The Foreign Office and Downing Street are preparing to send a strong signal to the Kremlin following its refusal to extradite Andrei Lugovoi, the former KGB agent suspected of murdering Alexander Litvinenko last November. On Monday, Russian prosecutors formally announced that Mr Lugovoi would not be handed over to the UK, on the grounds that Russia's constitution prevents his extradition.

The government was last night considering counter-measures to show Britain's extreme displeasure at the Kremlin's decision, and the seriousness with which it takes the "terrible" murder of Mr Litvinenko - a British citizen and fierce critic of the Russian president, Vladimir Putin. The options include the possible expulsion of Russian diplomats from the London embassy, and the withdrawal of cooperation in several areas, including education, trade, social affairs and counter-terrorism.

Yesterday a spokesman for Russia's foreign ministry, Mikhail Kamynin, warned that London was in danger of jeopardising its relationship with Moscow. "I don't understand the position of the British government. It is prepared to sacrifice our relations in trade and education for the sake of one man," he said, adding: "Our position is clearly in line with Russia's constitution and legislation."

British officials say the foreign secretary, David Miliband, is weighing the options. He will not announce a decision before next week, when the Foreign Office is expected to present a report to parliament setting out the punitive steps Britain will take. Foreign Office officials are bracing themselves for immediate and furious reprisals from Moscow, which could include the tit-for-tat expulsion of UK diplomats. President Putin has angrily dismissed as "stupidity" Britain's request for Mr Lugovoi's extradition. The Kremlin has already waged a campaign of intimidation and harassment against Britain's ambassador in Moscow, Tony Brenton, carried out by activists from the Russian youth group Nashi. Pro-Kremlin protesters picketed the British embassy, jumped in front of the ambassador's car and heckled his speeches. The anti-UK campaign has spread to the British Council, which has been raided by tax officials wearing balaclavas, and was last month told to move out of its offices in the city of Yekaterinburg. At the same time, both BP and Shell have been forced to yield major gasfield assets to Russia's state gas firm, Gazprom.

Since the Crown Prosecution Service charged Mr Lugovoi with murder in May, Kremlin officials have encouraged the Russian media to blame Mr Litvinenko's death on the exiled Russian former oligarch Boris Berezovsky and MI6. Television channels have also run lengthy interviews with a Russian who claimed that MI6 tried to hire him, and that Mr Litvinenko poisoned himself. In a surreal press conference in Moscow, Mr Lugovoi blamed the murder on Tony Blair, Mr Berezovsky, and the Georgian mafia.

Privately, Downing Street officials believe the Kremlin could have delivered Mr Lugovoi for trial in London, had it wanted to. At a minimum, Britain wanted Moscow to signal clearly that it regretted Mr Litvinenko's killing and would make sure nothing like it happened again. No such signal has been forthcoming.

The director of public prosecutions, Sir Ken McDonald QC, has made clear that it would not be "acceptable" for Mr Lugovoi to be tried in Russia instead, since the court system there is susceptible to political pressure.

On Tuesday, Gordon Brown expressed his frustration with Moscow. His spokesman said: "Russia's refusal to extradite Mr Lugovoi is extremely disappointing. We deeply regret that Russia has failed to show the necessary cooperation."

Mr Putin is personally incensed by the UK's failure to extradite Mr Berezovsky to Moscow, where he has been charged with money laundering and with attempting to plot a coup against the president.

Mr Litvinenko, who lived in north London with his wife and young son, died last November, aged 44, three weeks after being poisoned at the Millennium hotel in Mayfair with radioactive polonium-210. His associates later claimed that he wrote a deathbed statement accusing Mr Putin of being behind his poisoning.