The warning came as it emerged that a laptop seized from Isil in Syria contained research on how to make a biological bomb and religious justification to use it against civilians.
On Monday, Mr Cameron will unveil a number of “uncompromising” measures to help tackle British jihadists and fill the “gaps in our armoury”.
They will include stopping British fanatics from travelling to or returning from the war zones by making it easier to seize their passports.
He is also expected to tighten controls that can be put on the movement and activities of terror suspects within the UK.
It is the first time in three years that the threat level has stood at severe, just one short of “critical”, which would mean an attack is imminent.
The raised alert will lead to an increase in the number of armed police on the streets, especially around landmark sites and airports.
Theresa May, the Home Secretary, insisted that the move was not a result of any specific plot, but in light of the increasing dangers posed by British fanatics and other foreign fighters in Iraq and Syria.
The change also comes less than a week before a Nato summit in south Wales, which will be the biggest gathering of heads of state in the UK.
The White House said that it had consulted with the British Government about the heightened threat level, but there was no plan to raise America’s equivalent threat notice.
In a Downing Street press conference, Mr Cameron said: “What we’re facing in Iraq now with Isil is a greater and deeper threat to our security than we have known before.
“In Afghanistan the Taliban were prepared to play host to al-Qaeda. With Isil we are facing a terrorist organisation not being hosted in the country but seeking to establish and then violently expand its own terrorist state.
“We could be facing a terrorist state on the shores of the Mediterranean bordering a Nato State.
“We are in the middle of a generational struggle against a poisonous and extremist ideology that I believe we will be fighting for years if not decades.”
Mr Cameron said that the world had been “shocked and sickened” by the Isil murder of James Foley, the US journalist, apparently by a British terrorist.
He said that he was “absolutely satisfied that Isil has specific threats and will make specific threats to the UK”.
Whitehall sources said Isil and other terrorist groups in Iraq and Syria are planning attacks against the UK and other Western countries.
The Prime Minister said: “It was clear evidence that this is not some foreign conflict thousands of miles from home that we can hope to ignore. The ambition to create an extremist caliphate in the heart of Iraq and Syria is a threat to our own security here in the UK.”
He said that the battle was between Islam and extremists who used a “poisonous ideology” and “the most brutal forms of terrorism to force people to accept a warped world view”.
Mr Cameron has been under pressure to join the US in air strikes against the terror group. Downing Street has insisted that no request has been made, but the Prime Minister yesterday would not rule out military action.
“We must use all the resources we have at our disposal,” he said. “Learning the lessons from the past doesn’t mean that there isn’t a place for our military.
“The military were vital in driving al-Qaeda from Afghanistan and we support the US air strikes against Isil in Iraq. Military force is just one element of what we can do.”
There have also been calls for changes in the law to help strip passports from British jihadists.
The Prime Minister promised there would be no knee-jerk reaction, but added: “It is becoming clear that there are some gaps in our armoury and we need to strengthen them. We need to do more to stop people travelling, to stop those who do go from returning and to deal decisively with those who are already here.”
He went on: “Adhering to British values is not an option or choice. It is a duty to those who live on this island. In the end it is only by standing up that we will defeat extremism.”
Earlier this week Scotland Yard warned that the arrest rate for those suspected of being involved in Syria or Iraq-related terrorism had increased five-fold since last year.
The decision to raise the threat level was taken by the Joint Terrorism Analysis Centre, which operates out of MI5 and is independent of ministers.
Mrs May said: “We face a real and serious threat in the UK from international terrorism. I would urge the public to remain vigilant and to report any suspicious activity to the police.”
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