Defence Secretary Des Browne warned the Islamic republic against seeing Iraq as a "tool in a wider confrontation" with the international community, which is battling to persuade Tehran to curb its nuclear plans.
"Perhaps the most influential neighbour is Iran, and its behaviour remains a cause of deep concern," he said. "It has influence inside Iraq: the power to turn up or turn down the heat, to turn on or turn off the dialogue.
"It is not using that influence well. Support from within Iran goes to groups who are attacking our forces, but also to groups who are simply fuelling the sectarian violence," he added in a keynote speech in London.
"This is unacceptable, and also, in the end, counter-productive," he said.
Prime Minister Tony Blair recently warned both Iran and Syria that they had a "strategic choice" in the Middle East, between supporting terrorism and partnership with the West.
Browne, speaking at the Chatham House think tank, reiterated this warning.
"Iran must start seeing Iraq not as a tool in a wider confrontation with the West, but as a vital interest in its own right," he said.
"So the message to Iran is simple. Be a constructive partner, help yourself as well as the wider region – or face increasing isolation."