Israel's decision to erect new housing units in the West Bank dismayed the United States and the United Nations.

On Tuesday, Tel Aviv announced plans to build 900 new homes in Gilo, one of a dozen Israeli settlements in the illegally annexed East Jerusalem (Al-Quds), seized by the Israeli army along with the rest of the occupied West Bank during the six-day war in 1967.

The latest announcement drew sharp criticism from UN Secretary General Ban Ki-moon, who 'deplored' the construction as an 'illegal' action that would stunt peace efforts and cast doubt on the possibility of a two-state solution.

The US also voiced dismay at the approval of new Israeli housing on the occupied Palestinian land, accusing Israel of undermining US-backed efforts to relaunch peace negotiations.

Britain also criticized the continuous expansion of Israeli settlements for making it harder to secure an Israeli-Palestinian peace deal, while France also regretted Tel Aviv's persistence in going ahead with its construction activity.

But Israeli Interior Minister Eli Yishai fended off the criticism on Wednesday, saying freezing construction in Gilo was just like freezing construction in any other neighborhood in the West Bank.

"Construction in Jerusalem (Al-Quds) cannot be halted and Gilo is in Jerusalem," he said.

The decision to expand the Israeli settlements sparked outrage among Palestinians, who have repeatedly called for a complete freeze on new building before any new round of talks.

The Fatah-led Palestinian Authority, deeply disappointed with the failure of peace efforts, has launched a unilateral bid to seek statehood from the United Nations, despite divisions with the Gaza-based Hamas movement.

Europe and the United States discouraged the move on Tuesday, urging reconsideration of the recognition move and calling for a return to talks.

"I would hope that we would be in a position to recognize a Palestinian state but there has to be one first, so I think it is somewhat premature," said Swedish Foreign Minister Carl Bildt, whose country holds the EU presidency.

Palestinians in the Gaza Strip and the West Bank remain divided over political differences between Hamas resistance movement and the Western-backed Fatah.

The standoff between the rival factions hiked to a breaking point in June 2007 after Fatah staged a coup against the democratically elected Hamas government almost a year after its sweeping victory in the 2006 elections, forcing Hamas to limit its rule to the Gaza Strip.