The increased tension was reflected on the ground as Israeli police forces were placed on high alert across the country to guard against new attacks.
"There will be no political progress if the Palestinian Authority does not fight terror," Sharon said at weekly cabinet meeting.
It was the prime minister's first reaction since the bombing outside The Stage night-club - the first attack since Palestinian leader Mahmud Abbas declared a cease-fire at the Sharm el-Sheikh summit with Sharon on February 8.
Sharon, who also announced an end to Israeli military operations at the summit in Egypt, warned that the "self-restraint" would not continue unless there was firm action by Abbas's regime against groups such as Islamic Jihad which claimed responsibility for Friday's attack. "Israel has demonstrated self-restraint in recent time to allow for such progress but it is clear that without diligent action by the Palestinian Authority against terrorism, Israel will have to increase its military action."
The attack violated an informal truce which has been observed by Jihad and the other armed factions in recent months. Deputy defence minister Zeev Boim confirmed that Israel regarded Jihad as having broken the cease-fire and would therefore be actively targeted by the army.
Abbas "is not doing anything about Islamic Jihad, and therefore we will have to take care of the organisation ourselves," he told public radio. Israel is also holding Syria partly responsible for the bombing, accusing it of aiding and abetting attacks by hosting the leaders of groups such as Islamic Jihad and Hamas.