But Liberal Party heavyweights have rallied around Prime Minister Scott Morrison following his declaration the Coalition could recognise Jerusalem as the capital of Israel, including former prime minister John Howard who urged the government to move Australia’s embassy from Tel Aviv.

"The move may improve the prospect of a two-state solution,” Mr Howard told Fairfax Media.

Former diplomats and foreign affairs experts said such a provocative decision was counter to Australia’s interests, and questioned the timing of the announcement just days out from Saturday’s knife-edge byelection in the Sydney seat of Wentworth.

Reaction from Australia’s largest neighbour and the world’s most populous Muslim nation was swift and damning, with Indonesian Foreign Minister Retno Marsudi expressing solidarity with Palestinians while standing alongside Palestinian Foreign Minister Riyad al-Maliki.

"Indonesia reiterates that [the political status of] Jerusalem is one of six issues that have to be negotiated and decided as a sustainable solution," she said.

"Indonesia asks Australia and other countries to continue supporting the Palestine-Israel peace process in accordance with the principles that have been agreed and to not take steps that may threaten the peace process and world stability."

It is understood Mr Morrison told Indonesian President Joko Widodo in a text message conversation of the impending announcement before it was made to mitigate the blowback from Jakarta, while Foreign Minister Marise Payne phoned Ms Marsudi.

Fairfax Media has been told that moving Australia's embassy from Tel Aviv to Jerusalem was costed in June, with the Department of Foreign Affairs and Trade estimating a bill of between $150 million and $200 million.

Sources said the proposal was contemplated at senior levels of government - but never by cabinet - after Mr Trump moved the United States embassy earlier this year. It was apparently swiftly rejected based on multiple considerations, including the potential risk to relations with Indonesia and other countries.

Former Nationals leader and deputy prime minister Barnaby Joyce said Mr Morrison's announcement carried risks to trade with the Middle East.

“There would have to be concern about the Kuwaitis, the Qataris, the Saudis, the Jordanians, the Bahranis and whether they would put pressure on over this, especially in relation to agriculture exports,” Mr Joyce said. “It might be okay but you would want to plan for repercussions.”

A meeting of senior Arab diplomats from 15 countries in Canberra on Tuesday discussed possible trade responses.

"We talked about the ... impact and consequences of this position on the relationship between Australia and Arab countries,” said Palestinian diplomatic head Izzat Abdulhadi. "We talked about the size of trade between the Arab countries and Australia. We don't want this excellent relationship to be undermined or affected by this baseless position."

Mr Morrison has been open that his view on recognising Jerusalem as the capital - a highly contentious issue as the ancient city’s status remains unresolved under the long-running Israeli-Palestinian territorial dispute - was heavily influenced by the Liberal Party's candidate in the Wentworth byelection, Dave Sharma.

Mr Sharma, a former ambassador to Israel, has argued that accepting west Jerusalem as part of Israel does not threaten any resolution of the dispute under a future “two-state solution” as it is a geographical reality.

Labor foreign affairs spokeswoman Penny Wong angrily attacked Mr Morrison for his “change in bipartisan foreign policy just to try to hold on to the seat of Wentworth”.

But Mr Howard told Fairfax Media he “strongly” supported the government's announcement.

“The embassy should be moved to Jerusalem because it is the capital of Israel," he said.

Mr Howard added that as candidates, former US presidents Bill Clinton, George W. Bush and Barack Obama had all recognised Jerusalem as the capital of Israel.

Defending his decision, the Prime Minister said Australia strongly backed a two-state solution but the government wanted to challenge orthodox thinkng and the "taboo" question of Israel's capital.

He said he had found Mr Sharma's arguments persuasive and they could offer a "way forward" in the intractable dispute.

"We are committed to a two-state solution but, frankly, it hasn't been going that well," Mr Morrison said. "Not a lot of progress has been made. And you don't keep doing the same thing and expect different result."

Mr Howard also said he “remains a strong critic” of the Iran nuclear deal, which Mr Morrison has also vowed to review. America has pulled out of the deal though other signatories including Britain, France and Germany remain committed.

Australia is not a party to the deal but Israeli ambassador Mark Sofer said Australia’s voice carried serious weight in the world and its public views had influence.

Former prime minister Tony Abbott, who has long advocated a shift of the embassy, told Fairfax Media on Tuesday that “it’s a good move”. He added he was not worried about the impact on the relationship with Indonesia, nor about any perception that the timing of the Wentworth byelection risked signalling that foreign policy was being driven by local politics.

The Israeli ambassador to Australia, Mark Sofer, hoped the government's considerations would "come to a speedy and early conclusion in the right direction".

"What we're seeing here is a growing recognition of the facts on the ground and of course we welcome it."

Mr Morrison will make a final decision on the Iran deal by December.

Former Liberal foreign minister Alexander Downer tweeted that Mr Morrison's decision was "gutsy" and that Jerusalem is "obviously Israel’s capital".

But these political views were at odds with former diplomats and recent remarks from serving top foreign affairs officials.

“I think it is quite unfortunate a foreign policy issue of some substance should be debased in this way because of a domestic political consideration,” one former senior diplomat told Fairfax Media.

“Neither of these propositions is sensible … If you want a two-state solution it does not make sense to pre-empt unilaterally west Jerusalem and east Jerusalem … It’s a bit cute to say its consistent with a two-state solution.

Bob Bowker, a former ambassador to Egypt and one of the country’s most seasoned Middle East experts, said that “Australia has maintained a balanced approach on Jerusalem until now, because that is the approach that best serves Australia’s interests”.

“It is outrageous to depart from the principles of international law and at the same time to remove a major part of any balance within a negotiated solution by seeking to remove Jerusalem from the table.”

Former senior diplomat John McCarthy, who has served as Australia's ambassador in Jakarta, said any decision to move the embassy from Tel Aviv to West Jerusalem would be "very poorly regarded internationally”.

With Deborah Snow