Israel's interior minister has given final approval for the construction of 1,600 new settler homes in east Jerusalem, his spokesman said Thursday, prompting a furious reaction from Palestinian officials.

Spokesman Roei Lachmanovich said Interior Minister Eli Yishai had endorsed the construction of 1,600 units in the Ramat Shlomo neighbourhood and would shortly approve 2,700 additional homes in two other east Jerusalem settlement suburbs.

The move is likely to anger the international community, as it struggles to find a way to relaunch peace talks in a bid to head off a Palestinian plan to seek United Nations membership.

"He has approved 1,600 homes in Ramat Shlomo and will approve 2,000 more in Givat Hamatos and 700 in Pisgat Zeev," Lachmanovich said, referring to two additional Jewish neighbourhoods in east Jerusalem.

The 1,600-house construction in Ramat Shlomo has already caused a diplomatic rift between Israel and Washington.

Yishai's interior ministry first announced the project in March 2010, as US Vice President Joe Biden visited Israel and the Palestinian territories to lay the groundwork for new direct peace talks between the two sides.

The announcement was criticised by Washington, leaving Israeli Prime Minister Benjamin Netanyahu red-faced as he sat down for talks with Biden and prompting a mini-crisis in ties between the allies.

But Lachmanovich said the final approvals were "economic" not political, linking Yishai's decision to demonstrations over housing prices and the cost of living that have rocked Israel in recent weeks.

"These are being approved because of the economic crisis here in Israel, they are looking for a place to build in Jerusalem, and these will help," he said.

"This is nothing political, it's just economic."

The announcement drew a quick response from the Palestinian leadership.

"We strongly condemn the new Israeli decision to build new settlement homes in east Jerusalem," Palestinian negotiator Saeb Erakat told AFP.

He urged the United States and President Barack Obama "to reconsider their position rejecting the Palestinian move to go to the UN for recognition of a Palestinian state on the 1967 lines with east Jerusalem as its capital."

"We call on him to support this approach because it is the only way to preserve the two-state solution," he added.

Last week, Israel's interior ministry issued a similar final green-light for the construction of 900 new homes in the east Jerusalem settlement neighbourhood of Har Homa, which lies in the southwest of the city, neighbouring Bethlehem.

The approval of that project was swiftly condemned by much of the international community, including the United States and the European Union.

Israel captured east Jerusalem in the 1967 Six Day War, annexing it later in a move never recognised by most of the international community.

It claims both sides of the Holy City as its "eternal, indivisible" capital, and does not view construction in the east to be settlement activity.

The go-aheads for building in Ramat Shlomo and Har Homa come as the European Union works its partners in the international peacemaking Quartet, including the United States, United Nations and Russia, to draft a new framework for peace talks between Israel and the Palestinians.

Quartet members are hoping that the potential relaunch of negotiations could sway the Palestinians to drop their bid to seek UN membership for a Palestinian state this September.

But the Palestinians have said they will not return to the negotiating table without a halt to Israeli settlement construction and a clear framework for talks.

And they insist their UN bid is not incompatible with new negotiations and they have no plans to drop the bid, even if talks resume.