The 15-page report issued earlier this week called the Israeli government's strategy to build settlements in eastern Jerusalem "the biggest single threat to the two-state solution."
The report pointed to the Har Homa, Gilo and Givat Hamatos building projects to create more than 3,400 housing units, saying they are "part of a political strategy aimed at making it impossible for Jerusalem to become the capital of two states."
Palestinians have demanded a return to pre-1967 borders as a condition to return to peace talks, a move that would put some new or ongoing Israeli building projects in Palestinian territory, the Los Angeles Times reported Friday.
Imports of goods produced in the area could be boycotted, the report from the 27-nation bloc said.
Sara Hirschhorn, a scholar at Brandeis University's Schusterman Center for Israeli Studies, said a possible boycott would be difficult to implement and would "cross a line not crossed before."
"It also shows a lack of understanding on the part of the Europeans that the economies of Israel and the occupied territories are so embedded that it is really hard to distinguish between one and the other. The Palestinian and Israeli economies are also tied together, so [sanctions] could damage the Palestinians as well," she said.