Israel granted final approval on Thursday to a plan to build 800 homes near Gilo in annexed east Jerusalem, with construction tenders likely to be published within a few months, a Peace Now official said.
The move will mean the westward expansion of Gilo, a settlement neighbourhood located on the southern flanks of east Jerusalem, which lies very close to the West Bank town of Bethlehem.
The approval prompted an angry reaction from the Palestinians who said such actions hammered yet another nail in the coffin of a two-state solution.
Speaking to AFP, Peace Now's Hagit Ofran said a plan to build 800 housing units had on Thursday been published for validation in an Israeli newspaper in what was the last phase of the planning process.
"It means that now, a tender can be issued to begin to build 800 housing units west of Gilo," she said.
She said that the final approval had been granted by the interior ministry's district planning committee.
"Two weeks from the publication of the ad in the newspapers, the plan is valid and contractors may apply for a construction permit from the municipality," Ofran wrote on her blog.
"In the case of Gilo’s western slopes plan, which was initiated by the Israel Lands Administration, the contractors should win the bid in order to buy the rights to build, through a tender. Such a tender may be published in a few months."
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The Palestinians say settlement building is killing the chances of a two-state solution, with negotiator Saeb Erakat saying the only answer was for the international community to back Palestinian plans to seek upgraded UN status.
"Israel's decision to build 800 housing units is part of an overall Israeli plan which aims to destroy the two-state solution," he told AFP.
"We ask the international community to save the two-state solution... by voting for the Palestinian effort to obtain the status of non-member state at the United Nations," he said, referring to a resolution which is to be put to the UN General Assembly in November.
"The only thing that can stop these actions is for the world to vote in favour of the state of Palestine... by adopting this resolution."
With the peace process deadlocked for more than two years, the Palestinians have sought alternative means to secure their own state, seeking upgraded status at the United Nations, much to the dismay of Israel and Washington who say such a state can only emerge from bilateral negotiations.
Gilo lies in east Jerusalem, which Israel captured with the rest of the West Bank in the 1967 Middle East war and later annexed in a move not recognised by the international community.
Israel considers both west and east Jerusalem to be its "eternal, indivisible" capital, and does not view construction in the eastern sector as settlement activity.
The Palestinians, however, believe east Jerusalem should be the capital of their future state and are fiercely opposed to the extension of Israeli control over the sector.
The Gilo plans came to light a day after Israel radio said that Prime Minister Benjamin Netanyahu was planning to adopt parts of a controversial report which proposes the government legalise unauthorised settler outposts in the West Bank.
The report denies that Israel is a military occupying power and argues that international law does not prohibit the construction or expansion of settlements in the occupied West Bank.
According to Thursday's Haaretz newspaper, the cabinet could approve some of the report as early as Sunday.