Israel's housing ministry has announced new plans for almost 1,500 new settlement housing units in the West Bank and east Jerusalem, described as a "fitting Zionist response" to the new Palestinian unity government, backed by the Islamic militant group Hamas.

The announcement by housing minister Uri Ariel was immediately condemned by chief Palestinian negotiator Saeb Erekat, who accused Israel of planning a "major escalation" in response to the new unity government, and by the US ambassador to Israel, Dan Shapiro.

"When Israel is spat upon, it has to do something about it," said Ariel, a far-right member of prime minister Benjamin Netanyahu's coalition. Asked who had insulted Israel, he replied: "Our neighbours, and to a certain extent, the world."

The disclosure of the planned settlement construction was described by the justice minister, Tzipi Livni, as a political mistake. Livni was Israel's chief negotiator in the recently collapsed peace talks. She added that the move would "only distance us from the ability to recruit the world against Hamas."

The move comes amid the growing and bitter row between Israel and the US which, like the EU and UN, has vowed to continue working with the new Palestinian government.

That row in turn has sparked a round of loud recriminations in Israel itself, over Netanyahu's handling of the response to the formation of the new Palestinian government and over what has been seen in some quarters as a US betrayal.

The strongest criticism of Netanyahu came from opposition leader Yitzhak Herzog who accused the Israeli prime minister of overseeing "a complete collapse of Israeli foreign policy".

"Netanyahu talks and the world no longer listens," he added.

His comments came as Israeli anger at Washington continued to grow, with senior officials quoted anonymously in several Israeli media denouncing the US position.

"This isn't a failure of Israel diplomacy, it's a knife in the back," one senior official told Maariv.

Others accused the US secretary of state, John Kerry, of violating an understanding with Israel not to rush into recognising the Palestinian unity government.

Reports in Hebrew media claim Israeli officials in Washington have appealed directly to supporters in the US Congress to cut funding to the Palestinian Authority.

Galia Golan, who heads the Lauder School of Government, Diplomacy and Strategy compared the current problems between Israel and Washington to diplomatic low points in 1975 and 1991: "Netanyahu has been mistaken in his outlook with regard to the Obama administration all along. And it is a serious mistake. There is a view – we don't need them. But who else would back Israel the way that America has?

"And the risk is not that Washington pressures Israel but that it decides to do nothing and allows the European Union to pressure Israel further down the line."

Recent Israeli-US diplomatic relations have lurched between a series of disagreements about issues including US-led negotiations with Iran over its nuclear programme and blame for collapse of the Middle East peace process.

There have been repeated warnings from senior western diplomats that Israel risks increasing international isolation if it cannot negotiate an end to decades of occupation of Palestinian land.

The heated diplomatic wrangling has come as the Australian government has announced it will no longer refer to east Jerusalem as "occupied territory".

During a senate hearing, which focused on the country's foreign policy in the Middle East, attorney general George Brandis, responding to questions, rejected use of the term "occupied", saying it predetermined an issue subject to Israeli-Palestinian negotiations.

Most of the international community regards territory seized by Israel in the 1967 war as illegally occupied.