Human rights groups have appealed to Israel's high court to intervene.
However, the court ruling has found in favour of the government's argument that fuel supplies for vital activities such as running Gaza's only power plant would be maintained.
"We are convinced that, for now, there is no need to issue a stay ... especially as the [government] respondents undertook from the outset to ensure that the [fuel] reductions do not cause humanitarian harm," the panel of three justices wrote.
Israel's high court said in its ruling that it sought clarification on how, "given conditions in the Gaza Strip, it is possible to carry out the proposed [power] reductions without harming the population's vital humanitarian needs".
The court has in turn demanded extending deliberations on the proposed sanctions by at least 19 days.
Israel had planned to begin power cuts on Sunday, but Shlomo Dror, a senior defence ministry official, said the measure would be postponed.
"Clearly we cannot move on this until the high court has its final say," Dror told Reuters.
Israel's sanctions have coincided with the attendance of Ehud Olmert, the prime minister, and Abbas at US-sponsored talks at this week's in Annapolis, Maryland.
Israel withdrew troops and settlers from Gaza in 2005, but continues to control all its imports.
Cutting utilities is preferable to mounting a bloody invasion to stop Palestinians firing makeshift short-range rockets, Israel claims.
Hamas has condemned the sanctions as "blackmail" and hinted that Gaza's privations could stoke Israeli-Palestinian violence.
Dror said that Israel reduced fuels supplied to Gaza by about 13 per cent, depending on type, last month. Palestinian officials disputed this, reporting fuel cuts of between 40 and 50 per cent.
According to Israeli and Palestinian officials, Gaza's population uses about 200 megawatts of electricity, of which 120 are provided directly from Israeli power lines, 17 are delivered from Egypt, and 65 are produced at the Palestinian plant.