Many of Israel's Arabs live in the north, near the sea of Galilee

It would be the first city built for Israel's Arabs - who make up nearly 20% of the population - since the country was founded in 1948.

Mr Sheetrit said he wanted the plans to be completed and submitted for government approval by the year's end.

Meanwhile, Israel announced plans for 1,100 new homes in East Jerusalem - a decision condemned by Palestinians.

"Once again we ask the Israeli government to give peace a chance by stopping all settlement activity," Palestinian negotiator Saeb Erekat said.

Israeli settlements in the occupied territories are deemed illegal under international law.

'Modern city'

Mr Sheetrit announced plans for a new Arab city during a visit to the northern Arab town of Umm al-Fahm.

"I aspire to create a new Arab city in the Galilee and I am working on the planning for the project," the interior minister said.

"It will be a modern city, where young couples can afford to buy property and live just like in any other city in the world," he said.

Israel is home to about 1.2 million Arabs, who are the descendants of Palestinians who remained there after the state was formed in 1948.

Mr Sheetrit's announcement was welcomed by Samir Hussein, the Arab head of the local council in Dir Hanna, in the Galilee.

"I believe him and this sounds serious. This is a tremendously important step," he told Israeli news outlet Ynetnews.com.

"I haven't heard of such a plan, but I'm sure it is feasible and that there are many places in the Galilee where such a city can be built quickly," he added.

Mr Sheetrit was speaking only two days after hitting the headlines for his outspoken response to a rocket attack from Gaza that badly injured a young Israeli boy.

He told fellow cabinet members they should pick a neighbourhood in Gaza, give the inhabitants 24 hours to leave and "wipe it out".