An Israeli commission has approved the building of 920 new homes in occupied east Jerusalem, the municipality said on Wednesday, in a new blow to shaky peace talks with the Palestinians.

"The district commission has approved for construction 920 housing units in Har Homa," a statement said, referring to a neighbourhood in east Jerusalem, known in Arabic as Jabel Abu Ghneim, that has more than 10,000 residents.

The Har Homa project is part of a plan to build some 40,000 new homes over the next decade in neighbourhoods in both east and west Jerusalem, that the housing minister approved in June, a ministry official told AFP.

Until now specific aspects of this project were unknown.

Israel occupied and annexed the eastern half of the city after the 1967 war in a move not recognised by the international community or the Palestinians, who wish to make the Holy City the capital of their future state.

A total of 245,000 Palestinians live in east Jerusalem alongside more than 200,000 Jewish settlers.

Israel pledged to halt all settlement activity in the occupied West Bank when peace talks were revived at a conference in the United States last year.

But it considers the whole of Jerusalem its "eternal, undivided" capital and has insisted it will continue to build in both the city's eastern sector and in the larger West Bank settlement blocs that it intends to keep in any deal.

Little progress has been made in the negotiations so far, with the thorny settlements issue one of the major bones of contention.

The Jewish state's settlement expansion in Jerusalem has infuriated the Palestinians, who have accused Israel of obstructing peace efforts.

The United States has heavily criticised its close ally over its settlement activity in the occupied territories, with US Secretary of State Condoleezza Rice warning that the settlements issue must not block any peace deal.

"No party should be taking steps at this point that could prejudice the outcome of the negotiations," Rice said after meeting Palestinian president Mahmud Abbas in June.