The US has vetoed a UN Security Council resolution that would have condemned Israeli settlements as "illegal" and called for an immediate halt to all settlement building.
All 14 other Security Council members voted in favour of the resolution, which was backed by the Palestine Liberation Organisation (PLO), on Friday.
Mark Lyall Grant, the British ambassador to the UN, speaking on behalf of his country, France and Germany, condemned Israeli settlements in the West Bank. "They are illegal under international law," he said.
He added that the European Union's three biggest nations hope that an independent state of Palestine will join the UN as a new member state by September 2011.
The veto by the administration of Barack Obama, the US president, is certain to anger Arab countries and Palestinian supporters around the world.
An abstention would have angered the Israelis, the closest ally of Washington in the region, as well as Democratic and Republican supporters of Israel in the US Congress.
The UN says it opposes settlements in principal, but says that the UN Security Council is not the appropriate venue for resolving the decades-old Israeli-Palestinian conflict.
Susan Rice, the US ambassador to the UN, told council members that the veto "should not be misunderstood to mean we support settlement activity".
"While we agree with our fellow council members and indeed with the wider world about the folly and illegitimacy of continued Israeli settlement activity, we think it unwise for this council to attempt to resolve the core issues that divide Israelis and Palestinians," she said.
Palestinians said the veto is counterproductive to the peace process and will help Israel maintain illegal buildings.
"The American veto does not serve the peace process and encourages Israel to continue settlements, and to escape the
obligations of the peace process," said Nabil Abu Rdainah, a close aide to Mahmoud Abbas, the Palestinian president.
Al Jazeera's Cal Perry in Ramallah, West Bank, said the decision is "not going down well in the occupied West Bank".
"People are really wondering when some action is going to be taken," he said.
"People here are tired of a lack of a peace process; they are tired that the two sides are not talking; they are tired that they continue to hear, especially the US president Barack Obama continue to say that human dignity cannot be denied.
"He's been saying it all throughout the protests in Eqypt; he's been saying it all through the protests that continue to sweep across the region and the Palestinian people are saying: 'What about us?'"
Earlier, the Obama administration had tried to exert pressure on the Palestinian Authority to drop the UN resolution in exchange for other measures, but this was rejected by the authoirty.
The decision to back the resolution was made unanimously by the PLO's executive and the central committee of Abbas's Fatah movement on Friday, at a meeting to discuss Obama's appeal to Abbas by telephone a day earlier.
"The Palestinian leadership has decided to proceed to the UN Security Council, to pressure Israel to halt settlement activities. The decision was taken despite American pressure," said Wasel Abu Yousef, a PLO executive member.
Obama, who had said Israeli settlements in territories it captured in a 1967 war are illegal and unhelpful to the peace process, has argued that the resolution could shatter hopes of reviving the stalled talks.
In a 50-minute phone call on Thursday, he asked Abbas to drop the resolution and settle for a non-binding statement condemning settlement expansion, Palestinian officials said.
"Caving in to American pressure and withdrawing the resolution will constitute Goldstone 2," said a Palestinian official, speaking on terms of anonymity before the meeting.
He was referring to the wave of protest in October 2009 accusing Abbas of caving in to US pressure by agreeing not to submit for adoption a UN report that accused Israel and Hamas of war crimes during the invasion of Gaza two years ago.
Abbas maintains he insisted on submitting the report.
The Palestinians say continued building flouts the internationally-backed peace plan that will permit them to create a viable, contiguous state on the 1967 land, after a treaty with Israel to end its occupation and 62 years of conflict.
Israel says this is an excuse for avoiding peace talks and a precondition never demanded before during 17 years of negotiations, which has so far produced no agreement.
The diplomatic standoff is complicated by the effects of Middle East turmoil on the Arab League, whose members backed the resolution.
Egypt, a dominant member, and Tunisia are preoccupied with their transitions from deposed autocracies, and protests are flaring in Libya, Yemen and Bahrain.
Washington is trying to revive peace talks stalled since September over Israel's refusal to extend a moratorium on settlement building and Abbas's refusal to negotiate further until the Israelis freeze the illegal buildings.
'Nothing to lose'
Obama initially pressured Israel to maintain the moratorium only to relent in the run-up to the 2010 US mid-term elections to avoid, some analysts said, alienating key voters.
Instead of the resolution, Obama told Abbas he would back a fact-finding visit by a delegation of the UN Security Council to the occupied territories.
One PLO official said the leadership was determined not to cave in "even if our decision leads to a diplomatic crisis with the Americans", adding: "Now we have nothing to lose."
Since 2000, 14 Security Council resolutions have been vetoed by one or more of the five permanent members - Britain, China, France, Russia and the US. Of those, 10 were US vetoes, nine of them related to the Israeli-Palestinian conflict.