The announcement took to nearly 8,000 the number of homes Israel has approved for construction in east Jerusalem and the West Bank after the renewal of peace talks late last year in the US city of Annapolis.
However, Israel's annexation of east Jerusalem and integrating the surrounding West Bank areas within the much expanded Jerusalem city limits is not recognised under international law.
The Israeli interior ministry said the new housing units, planned for the ultra-Orthodox area of Ramat Shlomo, were approved by the regional planning board as part of Jerusalem's master plan. 'Negative effect'
Speaking at a press conference in the West Bank city of Ramallah, alongside Mahmoud Abbas, the Palestinian president, Rice said that Israeli policy towards settlements will have a "negative effect" on peace talks.
"I believe - and the United States believes - that the actions and the announcements that are taking place are having a negative effect on the atmosphere of negotiations," she said.
"No party should be taking steps at this point that could prejudice the outcome of the negotiations."
Rice also reiterated the US plans for an agreement to be reached before the end of the year.
"We've got a lot of work to do," she said.
Abbas thanked the US administration for its support, but criticised Israel's settlement building, calling it the "highest hurdle" in the negotiations.
"There are other issues too, including crossing points and road blocks which are hindering normal life in the West Bank and hindering the economic progress," he said.Growing expansion
David Chater, Al Jazeera's correspondent in Jerusalem, said that settlement activity has quickend since the Annapolis talks.
|Israel has quickened the pace of settlement|
expansion since the Annapolis talks[AFP]
"It seems to me that since the Annapolis meeting in Maryland, the pace of settlement expansion has actually been picking up," he said.
"On every visit the expansion of the settlements has been a problem.
"Rice is responding - she's spending more time on this issue than she ever has before. But it's all very well Condoleezza Rice saying this, what they [the Palestinian's] need is action on the ground."
A 2003 "road map" peace plan, reaffirmed by Israeli and Palestinian at Annappolis, requires a halt to all settlement activity on occupied land that the Palestinians want in a future state.
Lamis Andoni, Al Jazeera's Middle East analyst, said that the continued building reflects a lack of American political will to pressure Israel.
"Rice's statement that the settlements may harm the peace process underscores a lack of American will to pressure Israel to stop the illegal construction that is eating up Palestinian lands," she said.
"Washington is effectively allowing Israel to predetermine the final status of the West Bank and east Jerusalem rendering final status talks meaningless."