European Union foreign ministers have formally adopted an oil embargo against Iran over its nuclear programme.
The sanctions involve an immediate ban on all new oil contracts with Iran, while existing contracts will be honoured until 1 July.
Tehran denies that it is trying to develop nuclear weapons and says talks and not sanctions are the only way to resolve the dispute.
The EU currently buys about 20% of Iran's oil exports. Under the new deal, EU governments are expected to stop signing new contracts with Iran when the ban comes into place.
All existing contracts will have to be phased out by 1 July.
Additional restrictions on Iran's central bank are also expected to be agreed by EU ministers, although no further details have been given.
The BBC's Europe Editor says it is one of the toughest steps the EU has ever taken.
The EU and the United States are now working to persuade Asian countries to reduce their purchases from Iran as well.
Iran has already threatened to retaliate over the sanctions by blocking the Strait of Hormuz at the entrance to the Gulf, through which 20% of the world's oil exports pass.
The United States has said it will keep the trade route open, raising the possibility of a confrontation.
Late last year Iran conducted 10 days of military exercises near the Strait of Hormuz, test-firing several missiles.
Oil prices have risen already because of the increasing tension and the expected impact of an EU ban on oil supplies to Europe.
Earlier on Monday, the Pentagon said the aircraft carrier USS Abraham Lincoln, as well as a Royal Navy frigate and a French warship, passed through the Strait of Hormuz at the entrance to the Gulf without incident.
Iran conducted 10 days of military exercises near the Strait of Hormuz late last year, test-firing several missiles.
Russia says it regrets the EU decision but British Foreign Secretary William Hague says the sanctions are needed.
EU foreign policy commissioner Catherine Ashton says it is hoped Iran finally gets the message.
The sanctions will be phased in, but Barclays Capital commodities analyst Amrita Sen says oil prices will rise as supply shrinks.
Meanwhile, the price has already risen about 1% to $US110 per barrel.