Political sources in Tel Aviv confirmed on Monday that 600 new housing units would be added to Maale Adumim, a suburban-style settlement housing 30,000 colonists.
However, no building tenders have been published and security sources said the US, Israel's main ally and key mediator in its conflict with Palestinians, would be consulted before construction begins.
Located just east of Jerusalem, Maale Adumim straddles the mid-section of territory Palestinians seek for a viable independent state under a US-led peace "road map".
Political sources said the 600 new homes would extend the settlement eastwards, which could rupture direct trade and transport routes between the northern and southern West Bank.
Washington, which has Israel's pledge not to build beyond existing zones in West Bank settlements, has voiced reservations.
"Israel has made a commitment," US State Department spokesman Adam Ereli said. "We look forward to Israel abiding by that commitment and sticking by the road map.
"We have discussed with Prime Minister Sharon the need to make progress on the settlement issue, beginning with the removal of unauthorised settlement outposts."
The Bush administration has already expressed dismay at the Israeli government's failure to tear down dozens of unauthorised settlements and outposts erected during Prime Minister Ariel Sharon's tenure since 2001.
"Settlements and peace do not go together"
Saib Uraiqat, Palestinian negotiations minister
But Israeli officials say legal actions filed by settlers have bogged down attempts to remove outposts.
In April, Bush assured Sharon Israel could retain some West Bank land under any future peace deal with Palestinians if the Israeli prime minister carried out his unilateral plan to withdraw from the Gaza Strip - another occupied territory - next year.
The year-old road map, which also requires a halt to Palestinian resistance attacks on Israelis, has been stymied by persistent violence on both sides.
Palestinians accused Israel of poor faith in peacemaking.
"This is in total defiance of the road map ... and total defiance of President Bush's vision. Settlements and peace do not go together," Palestinian Negotiations Minister Saib Uraiqat said.
Sharon's blueprint to "disengage" from a bloody stalemate with Palestinians would evacuate all 8000 Jewish colonists from Gaza, along with just four of the 120 settlements in the West Bank.
But "disengagement" also entails keeping some illegal West Bank settlement blocs, including Maale Adumim, with the bulk of the 240,000 Jews on occupied land.
Palestinians, in revolt for almost four years, see the right-wing Sharon's "disengagement", along with a vast Israeli security barrier going up in the West Bank, as a ruse to dismember territory that would be the heart of the state they seek.
Refering to the illegal wall being built in the West Bank, Israeli Defence Minister Shaul Mofaz confirmed: "The security fence is not going back to the 1967 lines."