Prime Minister Benjamin Netanyahu, who is also the foreign minister, ordered the closure of Israel's embassy in Paraguay on Wednesday hours after the Latin American nation said it had decided to return its embassy from Jerusalem to Tel Aviv.
The United States and Guatemala also moved their embassies to Jerusalem in May and Netanyahu has attempted to persuade other countries to follow their lead.
"Israel views with great severity the unusual decision by Paraguay that will strain the ties between the countries," a brief statement from the Prime Minister's office said.
According to the Palestinian foreign ministry, the Palestinian Foreign Minister Riyad al-Maliki was responsible for Paraguay's decision to move back the embassy to Tel Aviv.
The ministry added Paraguay had said it would move its embassy back to Tel Aviv two weeks ago during al-Maliki's visit to the country.
Explaining the new Paraguayan move, the country's foreign minister, Luis Alberto Castiglioni, said: "Paraguay wants to contribute to an intensification of regional diplomatic efforts to achieve a broad, fair and lasting peace in the Middle East."
Former Paraguayan President Horacio Cartes travelled to Israel to inaugurate the new embassy in May. He was replaced last month by Mario Abdo, also a member of the conservative Colorado party.
Prime Minister Benjamin Netanyahu attended the inauguration ceremony at the Malha Technology Park, near the new Guatemalan embassy.
"It is an honor for me to be here today," Paraguayan President Cartes said at the ceremony. "The opening of the embassy holds special meaning, because it expresses the sincere friendship and the brave solidarity between Paraguay and Israel," Netanyahu said.
"I don't like binding or ambiguous positions. Our friendship is based on shared values, such as democracy, tolerance and dignity, lack of discrimination and peaceful coexistence," Cartes stated.
"This is a historic day that strengthens ties between Paraguay and Israel," he continued.
"A great day for Israel. A great day for Paraguay. A great day for our friendship," Netanyahu responded. "You have not only the support of our government but the profound gratitude of the people Israel."
"Paraguay helped the Jews escape Nazi Germany," the prime minister said of the historic bond between Paraguay and the Jewish people.
"We will never forget it. You did it before, during and after the Holocaust. It was an expression of compassion and generosity that will always be etched in our hearts. Paraguay also supported the establishment of the State of Israel and recognized Israel at the UN. We won't forget that, either," the premier added.
"You're an amazing friend to Israel," Netanyahu told Cartes. "Under your leadership, Paraguay made courageous moves in the international arena and refused to take part in the lies against Israel. It's time we do a lot more together and increase the cooperation between us. We've been discussing water, agriculture, security, and we are doing and want to do more. And we will."