Speaking at a joint press conference with Fayyad, Ban said: "Let us be clear, all settlement activity is illegal anywhere in occupied territory and this must stop."

Following Israel's announcement of 1,600 new housing units for a development in East Jerusalem last week, the Palestinian Authority pulled out of planned "proximity" talks demanding a complete halt to settlement activity.

'Restrictions and limitations'

Earlier, the UN chief visited observation point in the West Bank where he was shown the sprawling Jewish settlement of Givat Zeev, home to 11,000 Israelis.

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Following the tour, Ban said: "I have seen for myself plainly and clearly how Palestinians are living under such restriction and limitation.

"Even in your territory you are not able to develop or even maintain a normal economic life."

Ban also tackled the issue of Jerusalem, another major stumbling block to peace talks, saying: "We can and must find a way for Jerusalem to emerge from negotiation as the capital of two states, with the arrangement of holy sites acceptable to all."

Israel sees Jerusalem as the capital of a Jewish state and says that its position on an undivided Jerusalem is non-negotiable.

But the Palestinians want the predominantly Arab east of the city, which was annexed by Israel after the1967 Middle East war, as the capital of any future independent state.

The annexation of East Jerusalem has never been recognised by the international community.

Ban also pledged UN support for the building of Palestinian institutions in a bid to establish a Palestinian state.

Al Jazeera's Nisreen el-Shamayleh, reporting from the West Bank, said such institutions would likely run into problems in many areas of the occupied territory.

"The fact that Ban Ki-moon has endorsed this plan ... is a good sign, but in the field, when these projects start, there is going to be major confrontation between the Palestinians and the Israelis because the Israeli military controls most of the areas where the Palestinian Authorities wants to build these projects.

"The Palestinian Authority will need the UN's support in these confrontations."

Peace talks

Ban and the Quartet are hoping to get peace talks between the Palestinians and Israelis back on track after the Israeli announcement of the East Jerusalem development.

The announcement, which was made during a visit to Israel by Joe Biden, the US vice-president, also sparked a major diplomatic row between Israel and the US.

The move was seen as an insult to the US, a key ally of Israel, and Hillary Clinton, the US secretary of state, demanded Israel make specific gestures, including cancelling the most recent housing plan, to get talks back on track.

Clinton is due to to hear from Binyamin Netanyahu, the Israeli prime minister, in a meeting in Washington early next week.

Ban is due to visit Gaza, which has been under a crippling Israeli siege for nearly three years, on Sunday.