Prime Minister Scott Morrison has announced the government's decision to formally recognise west Jerusalem as Israel's capital in a speech on Saturday, following months of speculation since the government revealed it was contemplating a move.
"Australia now recognises West Jerusalem being the seat of the Knesset (Israel's legislative body) and west Jerusalem is the capital of Israel," Mr Morrison told an audience at The Sydney Institute.
The government will recognise East Jerusalem as Palestine's capital only after a settlement has been reached on a two-state solution, and the Australian embassy won't be moved from Tel Aviv to West Jerusalem until such a time.
While the government will delay the embassy move, it will establish a defence and trade office in Jerusalem and will also start looking for an appropriate site for the embassy.
Opposition leader Bill Shorten says the government's foreign policy shift without moving the Australian embassy as a "humiliating backdown" from a rushed by-election announcement.
Mr Shorten said the government's announcement ahead of the Wentworth by-election in October, where a large number of voters are Jewish, was "risky and foolish".
"What I'm worried is that Mr Morrison put his political interest ahead of our national interest," Mr Shorten told reporters in Adelaide.
"I regret that we've seen a complex debate derailed by reckless and fool behaviour."
Mr Morrison floated the idea of shifting the embassy in the dying days of the Wentworth by-election campaign, where more than 12 per cent of voters are Jewish.
The consideration sparked backlash from Indonesia and Malaysia, threatening a free trade deal which has now been delayed, although the Morrison government insists the delay was due to other reasons.
Following the pre-Wentworth election comments, Malaysia warned moving the embassy could fuel terrorism.
Labor's foreign affairs spokeswoman, Senator Penny Wong, said the decision to keep Australia's embassy in Tel Aviv proved the prime minister's pre-election proposal was a "cynical ploy to try to pretend he had shifted position for votes in Wentworth."
But Mr Morrison defended the October proposal to consider the move, saying it was about exploring options that could help achieve the two-state solution, especially as a "rancid stalemate has emerged."
"The very act of daring to ask that question drew the usual criticism," he told the audience at The Sydney Institute.
He said Australia intended to remain within the rules of the UN Security Council resolutions.
Community groups have responded to the announcement, with the Australia Palestine Advocacy Network saying they were "dismayed" and the move would slam the door on peace.
"As Israel claims exclusive sovereignty over all of Jerusalem and refuses to abide by United Nations resolutions calling it to withdraw from occupied East Jerusalem, we cannot give them a free kick," said the group's president Bishop George Browning.
The potential embassy move was previously welcomed by the Executive Council of Australian Jewry, who said the recognition of Jerusalem as capital would not prevent a future agreement between Israel and Palestinians.
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