Tuesday's authorisation comes despite repeated US appeals that Israel freeze settlement expansion.
Jewish settlements built on occupied Palestinian land are illegal under international law.
The latest housing plans threatened to raise tensions with the US just days before Prime Minister Ariel Sharon is to travel to New York to address the UN General Assembly.
Sharon is expected to meet US President George Bush and other global leaders during the trip.
The plans also drew swift condemnation from the Palestinians, who claim all of the West Bank for part of a future independent state.
The new construction is planned in Ariel, a sprawling settlement of 18,000 people deep inside the West Bank.
Ariel's mayor, Ron Nachman, said the government recently approved the construction of the 117 housing units in the centre of town, part of a plan frozen in the mid-1990s by late-prime minister Yitzhak Rabin.
Sharon is due to meet Bush and
other world leaders at the UN
The Israeli Defence Ministry and officials in Sharon's office confirmed the project's approval.
Nachman said that the Defence Ministry also had approved preliminary plans for a new 3000-home neighbourhood in the southern part of his settlement.
The project would nearly double the size of Ariel.
Defence Ministry officials confirmed the plan had received initial approval, though actual construction would need further authorisation.
The officials spoke on condition of anonymity under department regulations.
Strengthen and expand
Israel is in the final stages of withdrawing its troops from the Gaza Strip. But Sharon has repeatedly said he plans to strengthen and expand major West Bank settlement blocs, including Ariel.
Sharon says Israel will maintain these blocs, where the vast majority of the 246,000 West Bank settlers live, under a final peace deal with the Palestinians.
"All the prime ministers have built the settlement blocs, but I built more than all of them," Sharon was quoted as saying by the Israeli daily Yediot Ahronoth. "Settlement continues there and will continue."
The paper said he made the comments in a meeting on Monday with mayors from his ruling Likud Party.
Following the unilateral evacuation of all Gaza's 21 settlements and four small enclaves in the West Bank, Sharon has been trying to shore up support with Likud hardliners.
Sharon is now seeking support
from Likud hardliners
"The decision of the government to approve an additional 3000 housing units is a clear statement that this is the policy of strengthening the settlement blocs," Deputy Defence Minister Zeev Boim, a Likud hardliner, told Israel Radio.
Boim added that after Gaza, there would be no further unilateral pullbacks from territory claimed by the Palestinians.
"Those who think there ... will be a second and third disengagement are mistaken. Not with this government," he said.
Cabinet minister Haim Ramon said he would request clarification about the Ariel construction plans, but cast doubt on whether the vision would ever become a reality.
"To build 3000 housing units means building a new Ariel and this is a mistake because this will cause damage in the international arena," Ramon, a Labour Party member, said.
In a separate development, Israel's Supreme Court asked Sharon on Tuesday to seek a commitment from the Palestinians and the international community to protect empty synagogues in the Gaza Strip after Israel's withdrawal from the area is completed.
Israel's apex court wants Gaza
synagogues to be protected
The ruling added a new complication to the Gaza pullout, which Israel hopes to complete on 15 September.
The Palestinians say they are not responsible for protecting the houses of worship.
Tuesday's court ruling by a special, seven-judge panel came after Israel's chief rabbis ruled that it is forbidden to demolish synagogues.
The country's two chief rabbis are the country's top authorities on religious issues.