Hamas ministers on their first day in office today pledged to continue the battle for Israel's destruction and shrugged off warnings that they were leading the Palestinian Authority into a financial and political abyss.

International peace mediators warned that the $1billion annual foreign aid lifeline on which the West Bank and Gaza depends will be cut if the Islamist organisation fails publicly to recognise Israel's right to exist.

Canada announced that it was cutting off aid as of today, while Condoleezza Rice, the US Secretary of State, said that America was reviewing its Palestinian aid programmes to see which ones it would need to freeze. “The principle is very clear. We’re not going to fund a Hamas-led government, provide funding to a Hamas-led government,” she said.

In response Khaled Mashal, Hamas's exiled leader, appeared on Al Jazeera television this evening to pledge that the new administration could not countenance changing its stance on Israel.

He said he was confident that donors from the Middle East and other sympathetic nations would make up any shortfall. Algeria has deposited $34.5 million and more money is expected from Saudi Arabia, Russia, Kuwait and the United Arab Emirates, he added.

"We do not promise our people to turn Gaza into Hong Kong or Taiwan but we promise them a dignified and proud life in defence of their honour, their land and their pride. Our battle is only against the Zionist occupation," he said.

Mahmoud Abbas, the Palestinian President whose moderate Fatah party was trounced by Hamas in the January elections, swore in the 24-member Hamas-led Cabinet last night.

Two co-ordinated ceremonies had to be carried out in the Gaza Strip and the West Bank city of Ramallah connected by a videolink, as most Hamas ministers are banned from travel between the two territories they now control.

Israel has already stopped transferring tens of millions of dollars a month in taxes that it collects on behalf of the Palestinian government. Last night, the United States ordered its diplomats and contractors to have no contacts with Palestinian ministries. Today, Canada suspended aid payments.

The Quartet of the US, EU, Russia and the United Nations said that if Hamas refuses to renounce violence, recognise Israel and accept existing agreements there would "inevitably be an effect on direct assistance to that government". It said it noted today's announcements with "grave concern".

Ismail Haniya, the new Prime Minister, faces his first challenge next week when when March salaries are to be paid for some 140,000 government employees.

Mahmoud al-Zahar, a hardline Hamas figure, began exercising his powers as foreign minister by ordering staff not to have contacts with "hostile" countries. He said the new government would not give in to international pressure and announced that any country which shuns Hamas will be considered "an enemy of the Palestinian people".

Samir Abu Eisha, the new Planning Minister, told Reuters that he believed the West must review its position.

"The Europeans and others supported holding elections so, ethically, they should accept and respect the choice of the Palestinian people." He said that aid cutbacks would have dire consequences for the Palestinian people, putting pressure on education, health and social services."

Ehud Olmert, the leader of Israel's centrist Kadima party which enjoyed a worse-than-expected victory in elections on Wednesday, has vowed to draw Israel’s permanent frontier with the Palestinians by 2010.

He has said that in the absence of meaningful negotiations Israel will decide its own borders, evacuating some isolated Jewish settlements in the occupied West Bank but expanding bigger ones. Although this would displace tens of thousands of Jewish settlers, Palestinians say that such a move would annex land that is rightfully theirs, including East Jerusalem, and deny them a viable state.

Mark Regev, a spokesman for the Israeli Foreign Ministry, said: "If through their stubbornness and short-sightedness and extremism, they [Hamas] isolate the Palestinian government and turn it into a pariah in the international community, they will have no one to blame but themselves."

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