At a meeting, the EU foreign ministers issued a statement saying Mugabe's government had "prevented the deployment of an EU election observation mission."
"The EU remains seriously concerned at political violence, serious violations of human rights and restrictions on the media ... which call into question the prospects for a free and fair election," the foreign ministers' statement said.
As a result "targeted sanctions" were to be imposed, officials said.
EU spokeswoman Emma Udwin said "all 15 EU governments agreed it was preferable to withdraw all the observers" and also impose economic sanctions.
Officials said the EU would cut off $110 million in development aid for the 2002-2007 period.
In Zimbabwe, presidential spokesman George Charamba did not immediately return a call from The Associated Press seeking comment.
But Morgan Tsvangirai, the leader of the main opposition Movement for Democratic Change, discounted the EU moves.
"I don't think the European factor is any more relevant," he said in an interview with the Associated Press Television News before the EU decision.
"They (have been) talking about sanctions and not imposing any. ... It's too late now."
With the election less than three weeks away, "I don't think they will be able to influence anything," he said.
Mugabe, aged 77, is fighting for his political survival, and has imposed various restrictions on journalists and opposition parties to ensure victory. Tsvangirai is the biggest challenge to Mugabe's hold on power since he led the nation to independence from British colonial rule in 1980.
The sanctions came two days after Zimbabwe forced Pierre Schori, the head of the EU team, to leave the country. His expulsion set up a showdown with the 15-nation bloc that threatens to further isolate the southern African country.
Although Schori, who attended the EU foreign ministers meeting, recommended against imposing sanctions and withdrawing observers, officials said the EU governments felt they could no longer accept Mugabe's behavior.
The EU has been warning Mugabe's government for weeks it needed to improve political freedoms and stop violence by supporters of the ruling ZANU-PF party.
In their statement, the foreign ministers made clear the EU sanctions were "designed not to harm ordinary citizens of Zimbabwe or her neighbors, nor should they prevent dialogue between the EU and Zimbabwe."
The statement added that humanitarian aid for Zimbabwe would continue.
Schori was expelled after Mugabe's government refused to recognize his credentials as head of the EU mission to observe the March 9-10 presidential elections.
Zimbabwe has said it won't accept observers from EU members Sweden, Denmark, Finlad, Germany, Britain or the Netherlands. It accuses these nations of favoring his opposition.
There are currently 30 European observers in the country of a team that was supposed to number 150 eventually. Not all the observers are from EU countries; six are from Norway.
In Zimbabwe, four Christian clerics and seven of their followers were ordered to appear in court Monday in Bulawayo on charges they violated new security laws by holding an illegal prayer vigil for peace.
Several of the group were arrested as they knelt and prayed outside a police station where the group's leader, The Rev. Noel Scott, an Anglican pastor, had been taken. Among those arrested was Father Kevin O'Doherty, an American Roman Catholic missionary from Detroit who is based in Bulawayo.
The interdenominational group of churches said in a statement police banned a prayer procession Saturday to several local churches on grounds they could not guarantee walkers' safety. The group said participants in the vigil decided to use automobiles to move between church services rather than to march on foot.
Also on Monday, hundreds of government supporters hurled stones at the headquarters of Zimbabwe's opposition party in Harare on Monday, smashing windows and forcing pedestrians to flee, witnesses and the opposition said.
About 200 members of the ruling ZANU-PF party broke away from a march through downtown Harare and attacked the main offices of the MDC.
"They threw bricks and shattered the glass door to the building," said MDC spokesman Learnmore Jongwe, adding that there were no injuries.
Riot police moved in to restore order and witnesses saw some of the demonstrators herded into armored cars. A police spokesman said he had no details of the arrests.
Shops in the area were forced to close and police continued to patrol the street strewn with rocks.
"The MDC unreservedly condemns this violence which is being perpetrated by ZANU-PF...," Jongwe said.
A spokesman for the ruling party was not available.
Earlier, 3,000 supporters of President Robert Mugabe had marched on the British embassy in Harare, accusing the country's former colonial ruler of meddling in presidential elections due on March 9-10.
The pro-Mugabe demonstrators -- some wearing T-shirts with Mugabe's portrait -- carried placards saying: "Zimbabwe will never be a British colony again" and "Stop your racist politics in our country."
The crowd -- which staged a traditional ceremony near Mugabe's State House residence in honor of Zimbabwe's liberation war heroes -- sang revolutionary songs and chanted slogans threatening to go back to war to defend the country's independence.
Two government ministers joined the demonstration at the British embassy and later handed a protest note to diplomats.
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