Israel harshly condemned the Wednesday decision, with Prime Minister Benjamin Netanyahu comparing it to Nazi-era practices and saying the EU "should be ashamed."
"The labelling of products of the Jewish state by the European Union brings back dark memories," the premier said as he wrapped up a visit to Washington.
After the Nazis came to power in Germany in 1933, they imposed an economic boycott on the country's Jews, telling the public not to buy from them.
Justice Minister Ayelet Shaked, from the right-wing Jewish Home party and known for provocative statements, called the move "anti-Israeli and anti-Jewish," adding that "European hypocrisy and hate against Israel have surpassed all limits."
On Tuesday, in anticipation of the move, Energy Minister Yuval Steinitz called it "disguised anti-Semitism".
The foreign ministry summoned the EU envoy to the country.
The EU has insisted it was only clarifying existing rules on the place of origin for goods that will go on sale in the 28-nation bloc, adding that it had nothing to do with a boycott, which it says it does not support.
It amounts to a set of guidelines for labelling products from settlements in the Palestinian territories and annexed east Jerusalem as well as the Golan Heights, all occupied by Israel in the 1967 Six-Day War.
The settlements, deemed illegal under international law, are one of the main stumbling block to peace efforts, as those in the West Bank and east Jerusalem are built on land Palestinians see as part of a future state.
The Palestine Liberation Organisation said the EU decision was a positive step but that it did not go far enough, calling for a ban on such commerce.
- Limited economic effect -
It is not the impact on trade that has alarmed Israel, experts say, though the European Union is Israel's largest trade partner.
The goods in question account for only two to three percent of Israeli exports to the European Union, according to Israel's ambassador to the EU, David Walzer.
He estimates their value at $200 million (187 million euros) per year.
Signup to our newsletter and follow us on Facebook and Twitter!
"In fact, it involves only the agricultural products, the wine, the cosmetic products which require an origin label," said Ohad Cohen, head of external commerce at Israel's economy ministry.
"Labelling will at most involve $50 million in exports."
Most manufacturing exports from the settlements involve components or parts later assembled into finished products, making them difficult to trace.
Settlements also export farm goods, including dates, fruit and vegetables, along with wine from the Golan and cosmetics from the Dead Sea.
If required, Israel seems capable of finding new markets.
Dan Catarivas, head of international relations at the Manufacturers Association of Israel, said it was unfortunate that politicians were equating labelling with a boycott.
"We have to distinguish between the labelling that is imposed on us by the European Union and a boycott, which is completely unacceptable," he said.
- Memories of SodaStream -
Israel has been the target of a global boycott campaign aimed at ending its occupation, known as BDS (Boycott, Divestment and Sanctions).
According to an Israeli parliamentary report, the campaign has not so far had a noticeable impact. Over the past nine years, exports have risen from $7.8 billion to $15.6 billion.
But officials are unnerved by any bid to mount a campaign that they see as attempting to delegitimize the Jewish state.
They saw SodaStream, which manufactures a device for making fizzy drinks at home, become embroiled in boycott calls and close a factory in a West Bank settlement and relocate to Israel.
Beyond that, the differentiation between Israel and its settlements -- and its implications for the future -- puts Israelis on edge.
"Behind the legal quibbles, there is a willingness on the part of the Brussels bureaucracy to influence the outcome of Israeli-Palestinian negotiations, which in any case does not fall within its jurisdiction," foreign ministry spokesman Emmanuel Nahshon said.
While Netanyahu has reiterated his support for a two-state solution to the conflict, he currently leads one of the most right-wing governments in Israel's history.
The idea that all of the West Bank is or should be part of Israel has gained traction, including among some members of the government.
Akiva Eldar, political analyst for the Al-Monitor website, said both the government and opposition had adopted populist rhetoric over labelling.
"It's about knocking us out with patriotism, presenting Israelis as victims of anti-semitism by Europeans to play to a public traumatised by recent knife attacks," Eldar said. "And it works."