"The Israeli government has informed us via the mediator… that it will not comply with the release of the fourth group of prisoners scheduled for Saturday 29," Rajoub said after a meeting between Palestinian President Mahmoud Abbas and US envoy Martin Indyk.
The move will prove key in deciding whether the talks, resumed in July after a three-year hiatus, unravel or not.
Under the deal relaunching the peace negotiations, Israel said it would release 104 Arab prisoners held since before the 1993 Oslo Accords in exchange for the Palestinians not pressing their statehood claims via the UN.
Israel has so far freed 78 prisoners but there are growing fears Netanyahu's cabinet may block the final release, particularly that of Israeli Arab terrorists. As the release nears, victims of terror attacks have been mounting pressuring against the government in a bid to force it to backtrack on the release.
Nonetheless, it is far from clear there was any real possibility or intention to free the prisoners Saturday. The date was tentatviley set when the talks began. However, the release requires a Cabint vote and the names of those being freed must be made publically availbe some 48-hours before any release - two process which failed to take place - indicting that the Satruday release was far from certain to begin with. It is also possible Israel intends to free the prisoners, but at a later date.
Aslo, Israeli ministers have said previously that the prisoner releases were always conditional on progress in the talks, which had failed to materialise. Many also baulked at the inclusion of Israeli Arabs among the prisoners slated for release.
Rajub called the Israeli move a "slap in the face of the US administration and its efforts," and said the Palestinians would resume their international diplomatic offensive.
"Not releasing the prisoners will mark the beginning of the efforts in the international community to challenge the legality of the occupation," he said.
The talks have been teetering on the brink of collapse, with Washington fighting an uphill battle to get the two sides to agree to a framework for continued negotiations until the end of the year.
US Secretary of State John Kerry met Palestinian president Mahmud Abbas in Amman on Wednesday in a bid to salvage the talks, with US special envoy Martin Indyk meeting the Palestinian leader in Ramallah on Thursday.
According to Ma'an, Palestinian Authority Minister of Prisoners' Affairs Issa Qaraqe said in a statement that the release was crucial for any future progress in the peace talks and served as a test of Israel's reliability in the peace process.
"Israel has been playing an ugly game of blackmail ... using Palestinian prisoners as a pressure tool to obtain political gains, which we completely reject," Ma'an quoted Qaraqe as saying.
Qaraqe said that he holds Israel responsible for the consequences of not releasing the prisoners on time, warning of the "anger" in the Palestinian street.
Qaraqe, Ma'an reported, added that if Israel did not release all prisoners it committed to, the Palestinian Authority would have no choice but to turn to international bodies for recognition.
Israel has already freed three groups of veteran prisoners as part of a trust-building measure in ongoing peace talks, and are due to release a fourth group in April.
Israeli officials have hinted that release of the fourth group might be conditional on Abbas agreeing to extend talks beyond their end of April deadline, but Abbas has been reluctant to do so, citing ongoing settlement construction and a lack of progress in talks.