Security minister Ben Wallace said the chemical threat was the potential realization of "everybody's worst fear."
Wallace said there were reports of IS using chemical weapons in Syria and Iraq, where it controls large areas, and that Moroccan authorities apprehended a cell in February which was harbouring substances that could be used to either make a bomb or a "deadly toxin".
Mr Wallace said: "Experts have warned that their ambition is a mass casualty attack and they have no moral barrier to using whatever means possible."
It came after he told the Sunday Times: "The ambition of IS or Daesh is definitely mass casualty attacks.
"They want to harm as many people as possible and terrorise as many people as possible.
"They have no moral objection to using chemical weapons against populations and if they could, they would in this country.
"The casualty figures which could be involved would be everybody's worst fear.
"We have certainly seen reports of them using it in Syria and Iraq (and) we have certainly seen aspiration for it in Europe."
Mr Wallace also warned about the threat from "the enemy within" as terror groups, Russia and cyber attackers were trying to plant "traitors" in the Government, the military and leading businesses.
"There are traitors. We have to be on our guard for the enemy within," he said.
"The insider threat, as we would call it, is real and it can be exploited and there are people trying to do that as we speak."
Security services throughout the Western world remained on high alert for a New Year terror attack after ISIS distributed new propaganda about how to carry out mass killings.
The US Army said on Friday the chances of an attack on American soil were low but "undeniable".
Heavily armed police guard Christmas nativity with soldiers drafted in for New Year as Britain fears Berlin-style attack
A bulletin said: "There are no indications of specific threats to the US Homeland.
"However the threat from homegrown violent extremists (HVEs) in the United States is undeniable."
A separate bulletin revealed that two recent issues of Rumiyah, an ISIS propaganda publication, did "provide information on conducting knife attacks and using vehicles to cause mass casualties in populated areas."
Such tactics were used in recent attacks on civilians in Nice, France, Berlin and in Columbus, Ohio.