Palestinian official Ghassan al-Khatib denounced the decision to build in occupied East Jerusalem as "another Israeli violation of international law".
He said it threatened to derail efforts to resume negotiations that have not convened since a war in Gaza in December 2008.
Struggle against settlements
Khatib, a former cabinet minister who heads the Palestinian press office, said Palestinians would pursue what he called a "peaceful, legal, public struggle against Israeli settlement expansion and occupation".
A similar building plan proposed late last year for other parts of the Jerusalem area drew international condemnation.
Israel has also been criticised for court-approved evictions of Palestinians from homes in East Jerusalem and for threatening to demolish houses that it says were built illegally.
The newspaper said more homes were intended to be built near the Pisgat Zeev neighbourhood and the Palestinian area of Shuafat.
It said the original plan had been scaled back to 600 homes from an original 1,100 when it was learned some of the land was owned privately by Palestinians.
More than 200,000 Israelis already live in East Jerusalem and nearby areas of the West Bank that Israel captured in a 1967 war and considers part of its "eternal and indivisible capital".
Palestinians want East Jerusalem as the capital of a future state in the West Bank and Gaza Strip.
Binyamin Netanyahu, the Israeli prime minister, excluded the Jerusalem municipality, whose boundaries are not recognised internationally, from a 10-month moratorium in settlement building that he ordered in November.
The World Court has ruled that all the settlements Israel has built in occupied territory are illegal.