The European Union and the United States on Tuesday issued sharp warnings to Iran over its threatened violation of a deal suspending its nuclear activities, saying they may take the matter before the UN Security Council, which could impose punishing international economic sanctions on the Islamic Republic.

But Iran rejected the warnings and said nothing would stop it resuming work on converting uranium ore into a gas, a first step in enriching uranium into what can be either fuel for reactors or the explosive core of atom bombs. The United States charges that Iran has a covert nuclear weapons program.

The Iranian moves come as EU negotiators Britain, France and Germany are about to offer Tehran a package of trade, security and technology benefits in return for Iranian guarantees that it will not make nuclear weapons.

But two-and-a-half years into a UN atomic agency investigation of Iran's nuclear program, which Tehran says is a peaceful effort to generate electricity, a fundamental divide remains between the European trio and the Islamic Republic, with diplomats wondering if the process is reaching a critical point.

The EU wants guarantees to include Iran's abandonment of the nuclear fuel cycle while the Islamic Republic says it will never surrender the right to this crucial technology, which it says is guaranteed to peaceful users under the nuclear Non-Proliferation Treaty (NPT).

"If the Europeans don't accommodate the Iranians somehow, I think the Iranians might proceed with conversion (of uranium ore). Of course, that would be disastrous for everyone," a diplomat close to the IAEA, and who asked not to be named, told AFP.

The diplomat said the Iranians had sought to bring the issue to a head before hard-liner Mohamad Mahmood Ahmadinejad takes office later this week, succeeding the more moderate Mohammad Khatami.

"They wanted to show the moderates are on board and not have it look as if Ahmadinejad is escalating things," the diplomat said.

The Iranian threat to resume conversion "is designed to make the Europeans take another look" at their proposals, the diplomat said.

"The Europeans will have to be creative if they don't want a crisis," the diplomat added.

But an EU diplomat told AFP Tuesday that nuclear fuel cycle work remains the "red line" that would set off a Western attempt to take Iran before the Security Council.

This diplomat said the Europeans want to make their proposal, which may run to 20 pages, "as attractive for the Iranians as possible" but the bottom line is that they "not undertake any fuel cycle activity."

The European trio is expected to offer the Iranians guaranteed fuel for a nuclear power plant they are building at Bushehr and others they may build, trade benefits including civilian aircraft and parts they desperately need, as well as help towards joining the World Trade Organization and promises for Iran to be brought into talks on regional security issues, especially those touching on Iran's neighbors Iraq and Afghanistan.

Jozef Goldblatt, a non-proliferation expert at the International Peace Research Institute in Geneva, said the Iranians "expect something (more). They don't want to give up the enrichment technology."

Goldblatt said the Iranians feel they are in a strong position since the United States, with its military tied up in Iraq, is weakened, and because Security Council members China and Russia are close trading partners, with China buying Iranian oil.

Also leading the Iranians closer to taking a hardline position is, as Washington-based analyst Henry Sokolski said, the fact that they feel the United States has shown a "nuclear double standard" by helping India with its atomic program, despite India having nuclear weapons and having not signed the NPT to which Tehran belongs.

On the other hand, the Iranians still "don't want to step over the line and do things they think would trigger confrontation with the West," said William Hopkinson, an analyst at London's Chatham House think tank.

Non-proliferation expert Joseph Cirincione told AFP by phone from Washington that "the Iranians are tough negotiators but they are in a bind, they really have nowhere to go."

"They need to have a deal with the Europeans in order to make the kind of economic progress that the government has promised its people," Cirincione said.

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