Planning applications for 900 new housing units at a Jewish settlement in East Jerusalem have been approved by the Israeli interior ministry.
The planning and construction committee authorised the expansion of Gilo, which is built on land captured in 1967 and annexed to the Jerusalem municipality.
With the project yet to be reviewed, the public can still make objections.
The White House voiced dismay, saying the project made it harder to revive peace talks with the Palestinians.
Settlements on occupied territory are considered illegal under international law, though Israel disputes this.
Israeli media reported earlier that the government had rejected a request from Washington to freeze the construction work at Gilo.
US President Barack Obama's Middle East envoy, George Mitchell, is said to have made the request to Prime Minister Benjamin Netanyahu at a meeting in London on Monday.
 |  Netanyahu is showing again that he is spoiling any chance to start negotiations by continuing to create new provocations in Jerusalem  Hagit Ofran Peace Now |
Mr Netanyahu replied that the project did not require government approval and that Gilo was "an integral part of Jerusalem", according to Israel Army Radio.
His spokesman, Mark Regev, declined to comment on the reports, but repeated Israel's refusal to include areas annexed to Jerusalem as part of any accommodation of Mr Obama's call for "restraint" in settlement construction.
"Prime Minister Netanyahu... is willing to adopt the policy of the greatest possible restraint concerning growth in the West Bank, but this applies to the West Bank," he told the Reuters news agency. "Jerusalem is Israel's capital and will remain as such."
'Not ready for peace'
The Palestinian Authority has demanded a halt to all settlement construction before it will attend new peace talks, which were suspended last year.
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White House spokesman Robert Gibbs said: "We are dismayed at the Jerusalem Planning Committee's decision to move forward on the approval process for the expansion of Gilo in Jerusalem.
"Neither party should engage in efforts or take actions that could unilaterally pre-empt, or appear to pre-empt, negotiations."
America's position, he added, was that the status of Jerusalem must be resolved "through negotiations between the parties".
The BBC's Tim Franks in Jerusalem says Tuesday's announcement represents by far the largest batch of planning approvals for building on occupied territory since Mr Netanyahu became prime minister.
The 900 housing units, which will be built in the form of 4-5 bedroom apartments, will account for a significant expansion of Gilo. The interior ministry said construction work would be unlikely to start for another three or four years once the plans gained final authorisation.
A spokesman for Palestinian Authority President Mahmoud Abbas said the planning approval was "yet another step that shows and proves Israel is not ready for peace".
"This step will ruin every single attempt - European or American - to preserve the peace process," Nabil Abu Rudeineh said.
Israel's Peace Now movement, which opposes Jewish settlement activity, said Mr Netanyahu was "showing again that he is spoiling any chance to start negotiations by continuing to create new provocations in Jerusalem".
"This development is intended to torpedo progress that is taking place between US and Palestinians and Israelis on renewing the talks," said Peace Now's Hagit Ofran.
The UK Foreign Office also said it opposed the decision on Gilo.
"A credible [peace] deal involves Jerusalem as a shared capital. Expanding settlements on occupied land in East Jerusalem makes that deal much harder," a statement said.
Nearly 500,000 Jews live in more than 100 settlements built on occupied territory in the West Bank and East Jerusalem.
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