Israel does not want its relationship with Turkey to deteriorate any further, an official said on Tuesday, after Ankara said it was freezing arms trade and defence ties with the Jewish state.

"Israel does not want to see a further deterioration in its relations with Turkey," he told AFP, speaking on condition of anonymity.

"Over the past few months, there have been numerous attempts to create a positive dynamic in keeping the relationship between Jerusalem and Ankara but so far, those efforts have not succeeded."

Another Israeli official said the government was doing everything it could to try to limit the deterioration of the relationship, and not unwittingly cause it to worsen by getting into a war of words with Ankara.

But he admitted there was concern over the measures announced by Turkish Prime Minister Recep Tayyip Erdogan on Tuesday, just days after Ankara said it was expelling the Israeli ambassador and cutting all military ties.

"We are totally suspending our trade, military, defence industry relations," Erdogan was quoted as saying by Anatolia news agency.

The Turkish premier's office later clarified that he did not mean a suspension to commercial ties in general but merely "in the defence industry area".

The Israeli official said talks were under way with various different parties about the possibility of containing the situation but did not elaborate.

The government had not yet decided how it would react if it judged the situation to be beyond repair, he added.

Israel and Turkey were once close allies but relations have been in crisis since May 2010 when Israeli naval commandos stormed a six-ship flotilla trying to break Israel's naval blockade on Gaza, leaving nine Turkish nationals dead.

Ankara wants an apology, but Israel has refused, and the situation further deteriorated last week with the release of a UN report on the flotilla, which found the naval blockade to be legal although it chastised Israel for using "excessive" force.

Speaking shortly before Erdogan's announcement, Israeli Defence Minister Ehud Barak said it was "very important" for both parties to act rationally and not exacerbate the situation.

"Israel and Turkey are the two strongest, and in many respects the most important, countries in the Middle East," he said while on a tour of the occupied Golan Heights.

"There are disputes between us, and even in these disputes, it is very important that the two sides act rationally and not from the gut. It would be best for all of us to have stability in the region and to get things back to normal."

Shares in Tel Aviv fell more than three percent following Erdogan's announcement but later made up ground with the benchmark TA-25 index closing at 1,032 points, a drop of 2.79 percent.

Hardest hit were the energy stocks, with gas firms shedding more than five percent following a weekend report that Turkey had threatened to attack Cyprus if it began offshore drilling for natural gas.

In an interview with Turkish paper newspaper Today's Zaman, Turkey's EU Minister Egemen Bagis said: "It is for this [reason] that countries have warships," in reference to the Cypriot plans.

A senior analyst for Tel Aviv-based trade house USG Capital, however, said that while Erdogan's actions no doubt are influencing the Israeli market, Tuesday's falls could not be attributed solely to the crisis with Ankara.

"Wall Street and European markets are also dropping, which affects Israel," said Eli Ben David, adding that a security alert in the south, a social protest movement which has gripped Israel since mid-July and the Palestinians' bid for UN membership in September were all sources of instability for the market.

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