"I've heard the claim that our construction in Jewish neighbourhoods in Jerusalem distances peace," he said in remarks released by his office.
"It's this criticism that distances peace. These statements are detached from reality, they foster false statements by Palestinians."
An official in Netanyahu's office said Monday that Israel would be advancing the planning of more than 1,000 new units in two existing east Jerusalem Jewish neighbourhoods.
The news sparked fury among Palestinians, who oppose any effort to enlarge the Jewish presence in the annexed eastern part of Jerusalem.
Palestinian officials warned it would fuel further violence after months of near-daily clashes in east Jerusalem and called for emergency meeting of the UN Security Council over the Israeli plans.
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The European Union said the plans "call once again into serious question Israel's commitment to a negotiated solution with the Palestinians," warning of consequences for EU-Israel ties.
Washington said it was "deeply concerned" by the plans, noting that "moving forward with this type of action would be incompatible with the pursuit of peace."
But Netanyahu insisted Israel would not change course.
"We will continue to build in Jerusalem, our eternal capital," he said during a ground-breaking ceremony for a new port in southern Israel.
Israel seized Arab east Jerusalem during the 1967 Six-Day War and later annexed it, in a move never recognised by the international community.
Israel regards the entire city of Jerusalem as its "undivided capital" and does not see construction in the eastern sector as settlement activity.
The Palestinians want east Jerusalem as the capital of a future state.