Former Paraguayan President Horacio Cartes had traveled to Israel to inaugurate the new embassy in May. His successor, Mario Abdo, also a member of the conservative Colorado Party, took office last month.
Paraguay has reversed a decision to move its embassy from Tel Aviv to Jerusalem after just three months, prompting anger from Israel which responded by shuttering its embassy in Asunción and recalling its ambassador.
"The prime minister has asked the foreign ministry to close the Israeli embassy in Paraguay", the statement said, adding Paraguay's decision had cast a shadow on relations between the two countries.
Paraguay's foreign minister called Israel's reaction "disproportionate".
The move comes as Paraguay joins the effort to bring peace to the Middle East.
In line with most of Latin America, Paraguay was one of the 33 countries that voted in favor - compared to just 13 against and 10 abstentions - of the 1947 United Nations two-state partition plan for what was until then British Mandate Palestine.
"Paraguay wants to contribute to an intensification of regional diplomatic efforts to achieve a broad, fair and lasting peace in the Middle East", Foreign Minister Luis Alberto Castiglioni said.
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"Paraguay considers appropriate to reestablish the headquarters of its Embassy to the State of Israel", the statement said.
Castiglioni said Paraguay had always been "predictable in its worldwide relations" but that Cartes's move was "a distortion of this tradition and culture of respect for global law" and United Nations decrees. Most countries do not recognize Israeli sovereignty over the entire city and say its final status should be set in peace talks.
The Trump administration's decision to move the embassy flew in the face of that global consensus and it followed its recognition months earlier of Jerusalem as Israel's capital, another step the Palestinians fiercely opposed.
Guatemala became the first nation to follow suit when it officially declared on December 24 that it would be moving its embassy to Jerusalem.
In the decades since 1967, global consensus has been that the city's status must be negotiated between the two sides.
Mr Trump had unveiled the new U.S. stance in December 2017, declaring that he recognised Jerusalem as the capital of Israel.
Netanyahu has attempted to persuade other countries to follow the US' lead.
"There are over 85 countries who maintain their embassies in Tel Aviv and we are friends and historic allies of Israel".