The United States has described as "unfortunate" plans by the Israeli government to build 500 new illegal settler homes in East Jerusalem.

The US response came after a panel of the Israeli interior ministry gave approval on Monday for the new homes in Ramat Shlomo, a neighbourhood built on West Bank territory captured in the 1967 war and annexed to Jerusalem.

The announcement by Jerusalem's Planning and Building Committee to approve construction of 500 housing units in Ramat Shlomo is the first step in a long series of approvals needed before actual construction can begin and the process should take years.

The US criticised the decision, reiterating its view that settlements are "illegitimate".

"It is unfortunate that after the unequivocal and unanimous position last week of the international community, opposing construction in East Jerusalem, at this sensitive time the Israeli authorities chose to move forward," said Edgar Vasquez, a spokesman for the US State Department in Washington.

"We continue to engage at the highest level with the Israeli government to make our position absolutely clear - that we view settlement activity as illegitimate and that we unequivocally oppose unilateral steps that prejudge the future of Jerusalem."

Palestinian officials have voiced alarm - echoed in the international community - over the settlements, viewing them as a main obstacle to founding the independent state they seek in the West Bank and Gaza Strip with East Jerusalem as its capital.

An Israeli interior ministry spokeswoman did not immediately confirm Monday's committee decision, details of which were relayed to Reuters by an Israeli official on condition of anonymity.

Strained relations

The official said Israel hoped to avoid publicity around the move, one in a series of logistical and legal stages before construction begins. The number of new homes planned for Ramat Shlomo had been reduced, the official said, due to environmental concerns.

The US said last week such construction is not conducive to "peace in the region and a two-state solution".

Netanyahu, whose relations with US President Barack Obama have long been strained, also drew criticism from the White House earlier this month after about two dozen Jewish families moved into homes purchased in an Arab neighbourhood of East Jerusalem where about 500 settlers already live.

About 500,000 Israelis have settled in the West Bank and East Jerusalem, among 2.4 million Palestinians. The World Court says settlements Israel has built there are illegal, a view Israel disputes.