Britain bans public-sector boycotts of Israeli suppliers

* Palestinians dismayed by British move

* Say new rules only empower Israeli occupation

* Guidelines boost Israel (Other OTC: IRLCF - news) 's anti-boycott campaign (Adds Netanyahu lauding British decision)

LONDON, Feb 17 (Reuters) - Local (Other OTC: LOCMQ - news) authorities and public-sector organisations in Britain are banned from boycotting Israeli suppliers under new government rules, and violators could face severe penalties, the British government said on Wednesday.

Israeli Prime Minister Benjamin Netanyahu welcomed the new rules as a boost for his government's battle against a Palestinian-led international boycott campaign. Palestinians criticised the decision, saying it would reinforce Israel's occupation of territories they seek for an independent state.

The British Cabinet Office said that apart from where legal sanctions, embargoes and restrictions have been imposed, procurement boycotts by public authorities were "inappropriate".

In a statement, it said such boycotts "undermine good community relations, poisoning and polarising debate, weakening integration and fuelling anti-Semitism".

The new rules coincided with a visit to Israel by Cabinet Office minister Matthew Hancock during which, in a speech, he voiced opposition to "those calling for boycotts".

In welcoming remarks to Hancock and a British trade delegation to Israel, Netanyahu said: "I want to commend the British government for refusing to discriminate against Israel and Israelis and I commend you for standing up (for) the one and only true democracy in the Middle East."

The Palestine Liberation Organization (PLO) and the Palestinian-led Boycott, Divestment and Sanctions (BDS) movement, which campaigns for a boycott of all Israeli goods and questions Israel's legitimacy, condemned Britain's decision.

In a statement, the PLO said British local governments and publicly funded bodies would be forbidden "from exercising their democratic right and freedom of choice not to be complicit" in Israeli settlement-building on land Palestinians seek for a state.

"We strongly urge the British government to reconsider its positions and to rescind this regulation. This is not only a matter of law or politics, but also of moral responsibility."

The BDS said in a statement that Prime Minister David Cameron was "making a grave mistake similar to Margaret Thatcher's unwavering support of apartheid South Africa".

The British government said the World Trade Organisation's Government Procurement Agreement required signatories to treat suppliers equally, and therefore any discrimination against Israeli suppliers would be in breach of the agreement.

The government has not made boycotts a criminal offence, but those in sectors such as the health service, local authorities and some university student unions that impose them could face penalties, including fines and contract cancellations.

In 2014, the city council in Leicester in central England voted to boycott produce from Israeli settlements.

Last November, Israel was stung by European Union guidelines under which products made in the settlements must be labelled as such, rather than carry a "Made in Israel" label. Opponents of the labelling initiative fear it will boost the BDS.

The EU considers the settlements in occupied territory illegal under international law. (Reporting by Kylie MacLellan in London and Jeffrey Heller in Jerusalem; Editing by Mark Heinrich)