South Korea is suspending almost all commercial ties with North Korea, in response to evidence that the North was behind the sinking of one of its warships.
International experts have found parts of a torpedo that sank the ship on 26 March had lettering matching a North Korean design.
South Korean president Lee Myung-bak said those who carried out the attack, which killed 46 sailors, must be punished.
Trade will be frozen and merchant ships from the North will be turned away from South Korean ports. The measures are about as tough a response as the South could take, short of military action, the BBC reports.
Speaking at a memorial Mr Lee warned of a danger of complacency, saying the country shares a border with "one of the most warmongering nations on Earth."
North Korea denies any involvement in the sinking, calling the investigation results a "fabrication" and threatening war if sanctions are imposed. The country's main newspaper called the inquiry "an intolerable, grave provocation".
United States president Barack Obama has directed the American military to coordinate with South Korea to ensure readiness and deter future aggression from North Korea.
US Secretary of State Hillary Clinton, who is in Beijing, has urged China to co-operate with America on North Korea.
China has urged the Koreas to show restraint.
