The UK announcement comes after Israel opened up tenders for the construction of some 1,200 settlement homes in the so-called E1 area - a strategically important area east of Jerusalem. The plans have drawn widespread international condemnation. Israel has held off on plans to build in the area for decades under global pressure.
Miliband told the Commons the UK's "new approach" was necessary because plans for the E1 development in the West Bank would render a two-state solution "unviable" by "cutting through the heart of Palestine".
Elsewhere, he said war crimes "appear to have been committed" in Gaza in the years since the 7 October attack on Israel in 2023.
He said: "International humanitarian law imposes clear rules for states fighting wars, including to ensure access to food and medical supplies, to avoid mass displacement of civilians, and to avoid the targeting of civilians. Serious and international violations of this law, if proven, amount to war crimes.
"What has occurred, including the actions of the IDF, have been examined in depth by a number of organisations, including the UN Independent International Commission of Inquiry.
"The conclusions of these reports represent increasing evidence that war crimes appear to have been committed, and we support legal processes to determine this."
He added it was up to international courts to determine if Israel has committed a genocide in Gaza.
Israel's leaders have consistently rejected allegations of genocide, crimes against humanity and war crimes. They have insisted that Israeli forces have operated in accordance with international law.
Miliband began his statement to the Commons by referring to his Jewish roots and childhood experiences of visiting Israel, as well as recent antisemitic attacks in the UK.
He described himself as "a proud British Jew" and outlined his steadfast support for the state of Israel.
He said: "My personal story and that of thousands of British Jews is one of the many reasons why I say to anyone here or around the world who questions Israel's right to exist as a homeland for the Jewish people - you are wrong, and we will call you out whenever you engage in this attempt at the erasure of Israel."
Speaking from Jerusalem, Israeli President Isaac Herzog said the decision will "fall on the wrong side of history", adding: "In the current context, it would be a gross interference in the democratic elections of a sovereign nation."
Herzog said the move will directly harm Palestinians and urged foreign governments to turn towards "constructive dialogue" and cooperation, adding "sanctions are not a solution".
Israel also said it would remove of British representatives from the International Gaza Support Center in Kiryat Gat in southern Israel, and the termination of British activities to train Palestinian Authority forces in Judea and Samaria - how the Israeli government refers to the West Bank.
Donald Trump's ambassador to Israel Mike Huckabee earlier told the BBC that the US - Israel's most powerful ally - would "without a doubt" respond to the expected sanctions, warning of a "huge economic impact on British businesses".
He suggested action could be taken by individual US states as well as at a central, federal level.
Reacting to Miliband's announcement, shadow foreign secretary Tom Tugendhat claimed ministers are "enacting policies that the Foreign Office knows won't work".
He agreed that illegal settlements are wrong and "some Israeli ministers have indulged in hateful propaganda and incitement" but added "this isn't about Israel alone and it certainly isn't about reducing the complexity of the region to a single sentence. Sadly, the government is in the process of doing just that."

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