"There are maneuvers by the U.S. government plotting with a lackey government that has a right-wing president who is leaving in the next few months, who is not worthy of his people, who has been working actively against Venezuela," President Nicolas Maduro said in televised remarks.
He accused Panama of pushing for regional organizations to intervene in Venezuela. As a result, Maduro said he was cutting off diplomatic and political ties and freezing trade relations with Panama's current government "in defense of the homeland's sovereignty."
Panamanian President Ricardo Martinelli said in a Twitter post that he was surprised by Venezuela's decision.
"Panama only longs for its brother country to find peace and strengthen its democracy," he said.
The latest bout of diplomatic wrangling comes after weeks of anti-government protests in Venezuela, which are the biggest threat Maduro has faced since his election last year.
In a statement late Wednesday, Panama's government denied Maduro's accusations and said it had tried to encourage action by the Organization of American States to help promote dialogue, democracy and human rights in Venezuela.
"We reject as unacceptable the insults uttered by President Nicolas Maduro against our country and its highest authority. The foul language used is inappropriate for the president of a brother country," the statement said.
Last month Maduro expelled three U.S. diplomats form Venezuela, accusing them of conspiring against his government.
The United States expelled three Venezuelan diplomats last week in retaliation.
The State Department has repeatedly denied Venezuela's accusations that it's funding opposition efforts to topple Maduro's government or involved in other conspiracy plots.
"Venezuela, rather than trying to distract from its own failings by making up false accusations against diplomats from the United States, the government ought to focus on addressing the legitimate grievances of the Venezuelan people," U.S. President Barack Obama told reporters last month.