Speaking to reporters in Jerusalem, Lars Faaborg-Andersen, the EU's ambassador to Israel, also rebuffed charges by Prime Minister Benjamin Netanyahu that Europe was showing a pro-Palestinian bias.
And he warned that persistent Israeli construction on land seized during the 1967 Six Day War was fuelling private European moves to boycott products and services linked to the settlements.
"It is obvious, and we have made it clear to the parties, that there will be a price to pay if these negotiations falter," he said.
Since January 1, Israel has pushed ahead with plans for another 2,791 new settler homes in the West Bank, including annexed east Jerusalem, sparking a wave of international condemnation.
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By continuing to build up the settlements at the expense of a peace agreement, Israel was likely to find itself more and more shunned by the European public, the envoy warned.
"Not necessarily because of any decisions taken at a governmental level but because of decisions taken by a myriad of private, economic actors, be it companies, pension funds or consumers, who will be choosing other products on the supermarket shelves."
Faaborg-Andersen said moves within Europe to require separate labelling for goods manufactured in the settlements were gathering pace every time Israel announced a new round of construction.
So far, such initiatives are in place in Britain and Denmark, and Sweden, Finland and the Benelux countries are looking into it, he said.