Tougher sanctions have been imposed on more than 180 Iranian companies and individuals as EU countries seek to challenge Tehran to halt nuclear work.
European foreign ministers agreed to extend a list of people and institutions who will face sanctions.
They put on a show of solidarity at the meeting in Brussels, which followed days after the storming of the British embassy in Tehran.
But ministers failed to agree on imposing an embargo on Iranian oil.
When our new ambassador arrived in October, he was greeted with a Molotov cocktail over the wall.
Foreign Secretary William Hague
Britain’s Foreign Secretary William Hague said the pressure on Iran should be stepped up.
Before the agreement, Mr Hague had spoken of the need for “peaceful, legitimate, economic pressure, particularly to increase the isolation of the Iranian financial sector”.
He was backed by German counterpart Guido Westerwelle who said the aim was “to dry up Iran’s financial sources”.
The EU’s foreign policy chief, Briton Catherine Ashton, said additional measures against Tehran would “make it clear to Iran that we are very serious”.
The measures are primarily a response to a report suggesting Iran may be seeking to develop nuclear weapons – something officials there deny.
But it also follows the ransacking of the British Embassy in Tehran which spurred the UK Government to shut the Iranian embassy in London and order all diplomats to leave the country.
Mr Hague said the attack – ostensibly by protesters – was backed by the Iranian regime and was in breach of the Vienna Convention.
Dozens of hardline students smashed windows, set cars on fire and burnt Union flags as they attacked the building.
Baroness Ashton said an attack on the UK was considered an attack on the whole of the EU and Mr Hague said Tehran should be “ashamed”.
He added: “If any country makes it impossible for us to operate on their soil, they cannot expect to have a functioning embassy here.
“This does not amount to the severing of diplomatic relations in their entirety. It is action that reduces our relations with Iran to the lowest level consistent with the maintenance of diplomatic relations.”
The Foreign Secretary said he had been impressed by the “great and emphatic support” the UK had received from other European countries.
He also confirmed the tough action had been largely provoked by nuclear concerns, not the storming of the embassy.
“Our long-term concern is, of course, the nuclear programme,” he said.
In November, the International Atomic Energy Agency said Iran must provide further reassurance over whether it is seeking to develop nuclear weapons.
Mr Hague continued: “We have often had difficulties, of course, in operating in Tehran. We have tolerated those difficulties. Locally-engaged staff have been bullied and harassed by the Iranian authorities.
“When our new ambassador arrived in October, he was greeted with a Molotov cocktail over the wall. These things have happened and we have protested about them but this was on a totally different scale.”
In response to the UK’s reaction to the embassy attack, Iranian state TV said: “The foreign ministry spokesman… described the move as… hasty and added that naturally the government of the Islamic Republic of Iran would take further appropriate action regarding the issue.”
Germany, France and the Netherlands recalled their ambassadors for discussions over their own future relations and Italy indicated that it could follow suit.
Former foreign secretary David Miliband told Sky News that Iran might be “exasperating, difficult… destabilising the rest of the region” but military action would be unjustified.
If Iran develops nuclear weapons it would be unacceptable but they are at least two years away from this, he told Boulton and Co.
“Ingenious diplomacy” is key to stopping the situation escalating to war, the Labour MP added.
He also warned against allowing British concerns regarding the embassy attack to become muddled with the wider nuclear issue and “played into a drum-beat of war”.
Read Tim Marshall’s blog on Iran
The latest escalation of already-terse relations between the UK and Iran came after the UK severed all financial ties with Iranian banks in response to mounting fears over the country’s nuclear ambitions.
It was part of a wider international effort by the US and Canada to put pressure on the Islamic republic after the latest expert assessment increased fears the regime was seeking nuclear weapons.
Iran responded by passing legislation downgrading diplomatic ties with Britain, which was swiftly followed by the internationally-condemned attack on the embassy.
The Iranian foreign minister has apologised for the incident.
:: EU governments have also agreed to increase the pressure on Syria, adding 11 entities and 12 people to its sanctions list.
The move, which came out of the meeting of foreign ministers, are part of a push to challenge President Bashar al-Assad over his regime’s violent response to protests.