David Miliband arrived in Israel last night amid a dispute over vegetables and beauty products sold in British supermarkets which the Government insists are illicitly imported from Israeli settlements on the West Bank.

The Foreign Secretary is pushing fellow EU members to close a loophole in trade agreements that has allowed produce grown in the Jordan Valley to be imported duty-free. He was due to raise the issue with Ehud Olmert, the Prime Minister, Tzipi Livni, his Foreign Minister, and Ehud Barak, the Defence Minister, during his visit to the Middle East.

Israel is infuriated by the initiative, which it sees as an attempt to force its hand on the settlement issue. Many settlements thrive on growing out-of-season fruit and vegetables for the export market, such as bananas, avocados, cherry tomatoes and herbs. Others export factory-made goods, or skin-care products such as the Ahava brand made from the salty muds of the Dead Sea in the Jordan Valley.

Consumer groups fear that, unless the products are clearly labelled, shoppers could mistakenly buy the goods in the belief that they are helping impoverished Palestinian farmers. Marks & Spencer and Asda have already pulled products from the West Bank but critics are concerned that some chains, such as Waitrose, have merely labelled items as produce of “the West Bank”, without indicating the exact source.

The Government argues that Israel has reneged on promises to halt the building of new settlements on Palestinian land. A leaked British Government paper recently said that Israel had not only failed to curb settlement expansion, as promised at last year's Annapolis peace summit, but that settlement growth had accelerated.

“This initiative is a serious and substantial problem in relations between the two countries, and is generating a sense of crisis,” a senior diplomat told the Israeli newspaper Haaretz before Mr Miliband's visit.

Customs and Excise is examining whether Israeli companies operating out of the West Bank, occupied by Israel in the 1967 Six Days War, are using head offices registered inside Israel to bypass rules forbidding settlement products from benefiting from the trade agreement, officials said.

Aid groups are worried that, if the products are not clearly labelled, British consumers could unwittingly contribute to the continuation of the Jewish settlements, which Britain considers illegal under international law. “The illegal Israeli settlements in occupied Palestinian territories are disadvantaging the Palestinians,” said Mike Bailey of Oxfam in Jerusalem. “Our concern is that they are exploiting the Palestinians and their land, and products grown there should be grown by Palestinians. We are concerned that goods grown there should be properly labelled, so that consumers can make an informed choice.”

Waitrose said yesterday that it buys produce only from a small number of Israeli farms where Palestinians are employed. “Waitrose has a policy of full traceability in our supply chain, and high standards of worker welfare and agri-environmental sustainability are essential for any farm supplying us,” the company said.

Israel says that it has no legal mechanism to label products by their geographical origin, and insists that the current system, whereby EU customs officers check the origin of goods by a postcode supplied with the product, is a better system.

“This is 100 per cent political and zero per cent economic,” said one Israeli official. “It is very annoying, a small thing that keeps coming back and that we can't get rid of. It's a way of raising the settlement issue and expressing Europe's discontent.”

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