An Israeli minister has criticised the Australian government’s decision to formally recognise West Jerusalem as Israel’s capital, rather than the entire city.

Prime Minister Scott Morrison said Australia would also recognise East Jerusalem as the capital of Palestine in a two-state solution.

Tzachi Hanegbi, Israel's minister for regional co-operation and a Netanyahu confidant in the right-wing Likud party, said splitting the city was a "mistake".

"To our regret, within this positive news they made a mistake. There is no division between the east of the city and west of the city," he said.

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"Jerusalem is one whole, united. Israel's control over it is eternal. Our sovereignty will not be partitioned nor undermined. And we hope Australia will soon find the way to fix the mistake it made."

Mr Morrison’s announcement to formally recognise West Jerusalem as Israeli capital has drawn sharper criticism from other world leaders.

Palestinian chief negotiator Saeb Erekat said the move was born of Australian "petty domestic politics".

"All of Jerusalem remains a final-status issue for negotiations, while East Jerusalem, under international law, is an integral part of the occupied Palestinian territory."

Reuters

The Arab League issued a statement criticising the Australian decision as "blatantly biased towards the positions and policies of the Israeli occupation".

"Recognising West Jerusalem as Israel's capital while ignoring recognition of East Jerusalem as the capital of the state of Palestine shows glaring bias towards Israel," Arab League chief Ahmed Abul Gheit said.

"The Australian position is incomplete. Therefore, it stirs our dismay."

Bahraini minister Sheikh Khalid tweeted: "Australia's stance does not impact the legitimate Palestinian demands, first among them being east Jerusalem as the capital of Palestine, and it does not contradict the Arab Peace Initiative."

AAP

Mr Khalid has previously said Israel had the right to defend itself against Shi'ite Muslim Iran, which Bahrain blames for stoking unrest in the Sunni-ruled island state. Iran denies interfering in Bahrain.

Malaysia PM: "They have no rights"

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Malaysia has come out strongly against the Australian government's move to recognise West Jerusalem as Israel's capital, calling the decision "premature" and a "humiliation to the Palestinians".

Malaysian Prime Minister Mahathir Mohamad said: "Jerusalem should remain as it is now and not the capital of Israel.

"Jerusalem has always been under Palestine, so why are they taking the initiative to divide Jerusalem not belonging to them, but to divide the Arabs and the Jews? They have no rights."

Mr Morrison confirmed the foreign policy change on Saturday, which Labor has suggested it could reverse if it wins government in 2019.

The prime minister says Opposition Leader Bill Shorten needs to make the case for such a reversal before Australians vote.

"He will have to outline to the Australian community why he would want to now reverse that position and step Australia back from what should be, I think, a very strong stand of support for Israel," he told reporters in Canberra on Tuesday.

A decision on the capital came after the government flouted the idea of moving its Israeli embassy from Tel Aviv to Jerusalem in October, ahead of a crucial by-election in Wentworth.

It drew criticism from political rivals as a cynical ploy to buy votes in the electorate, which has a large Jewish population.

The step also drew rebukes from South East Asian trading partners, who feared Australia wading into the multi-generational political quagmire could fuel unrest.

Read more Israel welcomes Australia's west Jerusalem decision

The government now says it won't move its embassy until a two-state solution is reached, at which time it will also recognise East Jerusalem as Palestine's capital.

But Australia will establish a defence and trade office in Jerusalem and will start looking for an appropriate site for an embassy there.

The Malaysian foreign ministry expressed its strong opposition to the changes in a statement on Sunday.

"This announcement, made before the settlement of a two-state solution, is premature and a humiliation to the Palestinians and their struggle for the right to self-determination," the ministry said.

Labor foreign affairs spokeswoman Penny Wong said the shift in foreign policy was a "unilateral, risky decision".

"It's all risk for no gain," she told reporters in Adelaide on Sunday.

AAP

Labor believes Jerusalem should remain recognised as the capital of both Israel and Palestine until the final stages of negotiations on a two-state solution.

Israel's foreign ministry commended the move as a step in the right direction, while Palestinian chief negotiator Saeb Erekat said the announcement was born of Australian "petty domestic politics".

Mr Morrison has defended the new position, saying it was time to call out the "rancid stalemate" in progress towards a two-state solution.

A delayed multi-billion-dollar trade deal with Indonesia is expected to be on shaky ground as a result of the announcement.

- With AAP