Tripoli slammed Britain's "irresponsible and illegal" decision to recognise rebels as Libya's legitimate ruler and expel diplomats loyal to strongman Moamer Kadhafi from the London embassy.
British Foreign Secretary William Hague said Wednesday he had invited the rebel National Transitional Council (NTC) to take over the mission and appoint an official envoy in a major boost for the movement fighting Kadhafi's regime.
Libyan Deputy Foreign Minister Khaled Kaaim said the decision was "irresponsible, illegal and in violation of British and international laws."
He said the Kadhafi regime "will take necessary actions," and would argue against London's decision before tribunals in Britain and other international courts.
Rebel supporters unfurled the red, black and green flag of the Libyan opposition outside the embassy after Hague's announcement, although the Kadhafi regime's green flag still flew from the building itself on Wednesday afternoon.
Outside the embassy in the plush Knightsbridge district, about 20 demonstrators chanted: "We want to say thank you UK."
Demonstrator Muftah Abdelsamad, 57, who has lived in Britain since 1976, told AFP: "I was so happy I cried. We have been wanting this for six months now.
Hamad Khatab added: "They deserve this decision. Get out! We call them Kadhafi's rats because they support the killer, the murderer, they deserve to be kicked out."
"The prime minister and I have decided that the United Kingdom recognises and will deal with the National Transitional Council as the sole governmental authority in Libya," Hague told a news conference in London.
"We are inviting the National Transitional Council to appoint a new Libyan diplomatic envoy to take over the Libyan embassy in London."
He added: "We summoned the Libyan charge d'affaires to the Foreign Office today and informed him that he and the other regime diplomats from the Kadhafi regime must leave the UK. We no longer recognise them as the representatives of the Libyan government."
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Britain would also unlock £91 million ($149 million, 102 million euros) of Libyan oil assets frozen under a UN Security Council resolution so that the rebels could benefit from them, Hague said.
"This will help to ensure that the crucial provision of fuel is maintained. We will work hard with our international partners in the coming weeks to unfreeze further Libyan assets."
However, a source close to the NTC told Thursday's Guardian newspaper that the funds may be used to buy weapons.
"We are militarily engaged in removing Kadhafi," the source said. "Therefore it would be a bit strange to say that we are happy for you to have the no-fly zone, but rather that you didn't buy arms."
Britain is one of the leading nations in a NATO-led alliance that has conducted an aerial campaign against Kadhafi's regime since March, when the UN approved action to protect civilians.
London's move comes nearly two weeks after the Libya contact group, a body of major Western and regional powers, recognised the the NTC as Libya's legitimate government.
On Monday, Hague reiterated Britain's demands for Kadhafi to step down but said the Libyan leader may be allowed to remain in the north African country in an apparent shift in London's position.
Britain expelled Libya's ambassador in May after attacks on the British embassy in Tripoli, and has also kicked out several other diplomats including the military attache.
It has no diplomatic representation in Tripoli but a Foreign Office special representative is based in Benghazi, the eastern city which is home to the NTC.
Guma Al-Gamaty, the NTC co-ordinator in Britain, told BBC radio he would not become the new ambassador but hailed the decision.
"This is about a great move. We welcome this move and we are grateful to the British government for this step. It's very significant," he said.
The London embassy, known under Kadhafi's regime as the Libyan People's Bureau, has had a chequered history. British policewoman Yvonne Fletcher was shot from the embassy in 1984 while policing a peaceful demonstration there.