Britain shut Iran's embassy in London and expelled all its staff on Wednesday, saying the storming of the British mission in Tehran could not have taken place without consent from Iranian authorities.
Foreign Secretary William Hague also said the British Embassy in Tehran had been closed and all staff evacuated following the attack on Tuesday by a crowd that ransacked offices and burned British flags in a protest over sanctions imposed by Britain on Tehran.
Iran warned that Britain's closure of the Iranian embassy in London would lead to further retaliation.
Tuesday's incident was the most violent so far as relations between the two countries steadily deteriorate due to Iran's wider dispute with the West over its nuclear programme.
Analysts say it also appeared to reflect factionalism within Iran's ruling establishment, a unique hybrid of clerical and secular authority, and efforts by hardliners to undermine President Mahmoud Ahmadinejad.
On top of its ban on British financial institutions dealing with Iran and its central bank last week, Britain has called for further measures and a diplomatic source said London would now support a ban on oil imports from the Islamic Republic.
Hague said Iranian ambassadors across the European Union had been summoned to receive strong protests over the incident. But Britain stopped short of severing ties with Iran completely.
The Iranian charge (d'affaires) in London is being informed now that we require the immediate closure of the Iranian embassy in London and that all Iranian diplomatic staff must leave the United Kingdom within the next 48 hours, Hague told parliament.
We have now closed the British embassy in Tehran. We have decided to evacuate all our staff and as of the last few minutes, the last of our UK-based staff have now left Iran.
France, Germany and the Netherlands said they were recalling their ambassadors for consultations. Germany said it would offer to take over consular duties on behalf of Britain in Tehran.
It was the worst crisis between Britain and Iran since full diplomatic relations were restored in 1999, 10 years after Ayatollah Ruhollah Khomeini's fatwa that author Salman Rushdie could be killed for writing The Satanic Verses.
Hague said it was fanciful to think Iranian authorities could not protect the British embassy, or that the assault could have taken place without some degree of regime consent.
This does not amount to the severing of diplomatic relations in their entirety. It is action that reduces our relations with Iran to the lowest level consistent with the maintenance of diplomatic relations, he added.
Mindful of the 1979 seizure of the U.S. embassy in Tehran, when radical students held 52 Americans hostage for 444 days, Britain waited until all its two dozen diplomatic staff and dependents had left the country to announce its move.
Iran's state TV quoted a foreign ministry spokesman as calling London's closure of the Iranian embassy hasty. Naturally the government of the Islamic Republic of Iran would take further appropriate action regarding the issue, a news reporter said.
RIFTS IN IRAN
Negotiations on Iran's nuclear programme were now dead, said Ali Ansari, director of the Institute for Iranian Studies at St Andrews University in Scotland.
What you are moving into is a period of containment and quarantine. I don't think we are into a military confrontation, but we are into a period of containment and they (the West) are going to try and tighten the noose.
The attack also exposes widening rifts within Iran's ruling elite. It appeared to be part of a move by the conservatives who dominate parliament to force Ahmadinejad to heed their demand to expel the British ambassador.
Ahmadinejad and his ministers have shown no willingness to compromise on their refusal to halt Iran's nuclear work but have sought to keep talks open to limit what sanctions are imposed.
The West believes the programme is aimed at building a nuclear weapon, a charge Tehran strongly denies.
This incident was planned by elements who are not opposed per se to negotiations but want to stop them merely because of their own petty political struggles, said Trita Parsi, a U.S.-based expert on Western-Iranian relations.
The push to get the UK ambassador out came from parliament which is headed by Ali Larijani, Parsi said. When Larijani was chief nuclear negotiator Ahmadinejad carried out a similar campaign against negotiations.
Ahmadinejad was once seen as a protege of Supreme Leader Ayatollah Ali Khamenei. But he has faced challenges this year from hardliners who fear his faction threatens the role of the Islamic clergy in the political system that emerged after Iran's 1979 revolution: a parliamentary one, with a directly elected president overseen by a powerful cleric.
Khamenei's recent comment that the directly elected presidency could be replaced with one elected by parliament has been welcomed by those who want to clip Ahmadinejad's wings.
Conservative newspapers trumpeted the embassy seizure.
The daily Vatan-e Emrouz declared: Fox's den seized, referring to Britain's nickname the old fox which reflects a widely-held view in Iran that London still wields great power behind the scenes in Iranian and international affairs.
While Iranian police at first did not stop the protesters storming the embassy gates, they later fired tear gas to disperse them and freed six Britons held by demonstrators.
Iran's Foreign Ministry expressed its regret for the unacceptable behaviour of few demonstrators.
The protesters hit back, saying they had been seeking to answer to the plots and malevolence of this old fox and the Foreign Ministry should not sacrifice the goals of the nation for diplomatic and political relations.
We expected the police to be on the side of the students instead of confronting them, said a statement by a group calling itself the Islamic community of Tehran universities.
Britain imposed sanctions on the Iran central bank last week after a report by the U.N.'s International Atomic Energy Agency suggested Iran may have worked on developing a nuclear arsenal.
Iran, the world's fifth biggest oil exporter, says it only wants nuclear technology to generate electricity.
Britain has not backed a ban on Iranian oil imports, but that could now change, the diplomatic source told Reuters, and London will likely back a call by France to do just that and impose sanctions on a scale that would paralyse the regime.
The United States, which cut diplomatic relations with Iran after its embassy was stormed in 1979, has not bought Iranian oil since the 1990s, but has not taken any measures against Iran's central bank. That would cripple Iran's economy as it would not be able to process payments for its vital oil exports.
(Additional reporting by Hossein Jaseb and Ramin Mostafavi in Tehran, Adrian Croft and Tim Castle in London and Parisa Hafezi in Istanbul; Writing by Jon Hemming; Editing by Andrew Roche)