Israeli Prime Minister Benjamin Netanyahu has challenged US concerns over moving the American embassy to Jerusalem and said a move will help the peace process to progress.

During his election campaign, US President Donald Trump promised to move the embassy from Tel Aviv to Jerusalem, whose status is one of the thorniest issues of the Israeli-Palestinian conflict.

"The transfer of the American Embassy to Jerusalem not only will not harm the peace process, but the opposite," Netanyahu said in the statement on Sunday.

"It will advance it by correcting a historic injustice and by smashing the Palestinian fantasy that Jerusalem is not the capital of Israel."

The statement from Netanyahu's office came after US Secretary of State Rex Tillerson said Trump is still assessing the impact of the potential move.

"The president is being very careful to understand how such a decision would impact the peace process," Tillerson said.

He said Trump's decision would be informed by feedback from all sides, including "whether Israel views it as helpful to a peace initiative or perhaps a distraction".

The Palestinians and the Arab world fiercely oppose a move, and the international community has warned that it could spark fresh unrest.

Palestinians argued that moving the embassy would prejudge one of the most sensitive issues in the conflict, undermining America's status as an effective mediator.

Former US presidents have repeatedly waived a US law requiring the embassy to be moved to Jerusalem.

The most recent waiver, signed by Barack Obama, expires on June 1. Trump is expected to sign a six-month renewal of the waiver, as he continues deliberating, before it expires.

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In another sign that the White House is proceeding cautiously, Trump's ambassador to Israel, David Friedman, plans to work out of the current embassy in Tel Aviv rather than out of the US Consulate in Jerusalem, as some had urged him to do.

Israel occupied the West Bank and East Jerusalem in 1967. It later annexed East Jerusalem in a move never recognised by the international community.

In 1980, Israel declared "reunited" Jerusalem its capital in a move unrecognised by major states.