Ever since Hamas was democratically elected in the West Bank and Gaza in January 2006, the Palestinian economy has been living under an internationally endorsed policy of sanctions. Imposed by Israel and the international community until Hamas renounced terrorism and recognizes the Jewish State's right to exist, these sanctions have evolved in nature and have had a devastating effect on an already fragile Palestinian economy. They have hit most hardly Gaza but they have also strongly impacted the West Bank, which remained under de facto siege until June 2007 when Hamas took over Gaza and severed its links with the Abbas government in the West Bank. Per capita income in the West Bank and Gaza fell by 34% per cent between 2001 and 2008 and poverty have reached 60% of the population since 2006. The situation in Gaza has further deteriorated since 2007 as Israel tied its siege causing the manufacturing sector to collapse, the banking sector to stall, and unemployment to reach over 45 per cent. The latest Israeli war on Gaza in December 2008 only aggravated the dire situation as it was compounded with Egypt's decision to close off its borders with the Strip. Over one third of the population in Gaza are homeless today and two third are food insecure. The aim of this paper is to analyze the rationale and impact of the sanctions on Israeli-Palestinian relations. The first part will explore the contradictory politics of Egypt and the international donor community who did not want to finance a Hamas government but still wanted to help the Palestinian people and their state building process. The second part of the paper will then examine Palestinian economic response to the sanctions by exploring how the economies of the West Bank and Gaza continued to diverge. It will focus particularly on the political economy of the informal tunnels in Gaza and their impact on poverty and power structures in the Strip. It will also assess how the over 1600 underground tunnels tied Gaza to Egypt while severed its links to Israel and the West Bank. Finally, the paper will assess how far the sanctions enabled Israel to absolve itself of its responsibilities of the occupation and the extent to which a Palestinian campaign of BDS against Israel is necessary or risks to be futile.