The fragile agreement, in which the government said it would allow Islamic law in the region in exchange for militants laying down their arms, was left in tatters when a soldier was killed in an ambush.
It came just a day after two local officials were beheaded and Taliban fighters began patrolling Mingora, Swat's main town.
A Taliban spokesman blamed the government and military for provoking the violence saying it had sabotaged the peace process to appease the United States.
Muslim Khan, said that the controversial peace deal "practically stands dissolved".
"This is not our army, this is not our government. They're worse enemies of Muslims than the Americans," he said. "They're US stooges and now it's clear that either we'll be martyred (killed) or we'll march forward," he added.
The attack came despite Pakistan making further concessions to the Taliban by establishing an Islamic appeal court. Officials had insisted that by carrying out its part of the agreement, the government could gain more support from the public to take action against the Taliban if the militants violate the pact.
The apparent collapse of the deal raised the prospect of the Pakistani army having to retake control of Swat where the militants are deeply entrenched and where the army conducted an unsuccessful operation until February. Rejoining the battle in Swat would involve heavy casualties and uprooting thousands more people from their homes.
Mian Iftikhar Hussain, Northwest Frontier Province Information Minister, who helped negotiate the pact said: "We set up Islamic courts, we gave them Islamic judges, yet they do not accept this. They have some other agenda. We will fight them and, God willing, these handful of miscreants will be defeated and the nation will prevail."
Since the peace agreement was signed in February, militants have infiltrated neighbouring districts of Buner and Dir where fierce fighting continued.
The Pakistani army last night accused militants of holding 2,000 villagers in Pir Baba in Buner as human shields to stop an offensive being launched.
The growing strength of the Taliban has raised alarm in the United States which has openly questioned the ability of the government to stand up to the militants.
Washington has expressed concern, with Barack Obama acknowledging the government was "very fragile" and secretary of state, Hillary Clinton, saying Pakistan was "basically abdicating" to the Taliban.
Mr Obama will present his strategy for defeating the militants to Asif Ali Zardari, the Pakistani President, and Afghanistan leaders when they arrive in Washington on Wednesday.
Washington has said it wants Pakistan to fight the militants, not talk to them, and is unlikely to mourn the three-month-old deal in the region if it breaks down.
Mr Zardari hopes to build American confidence in his government's ability to tackle militancy and secure a massive aid package.
It has emerged American officials are increasingly concerned about the vulnerability of Pakistan's nuclear arsenal as the country's security deteriorates.
The New York Times published a report saying Mr Obama's government was worried Taliban militants could snatch a weapon in transport or get sympathisers to infiltrate laboratories or fuel-production facilities.
The US does not know where all of Pakistan's nuclear sites are located, and its concerns have intensified in the last two weeks as the situation has deteriorated.
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