The United States is "deeply concerned" by Israel's plan to build a new housing project in the southeast Jerusalem neighborhood of Har Homa, the State Department said on Tuesday.
The State Department warned that such "unilateral actions" were detrimental to the peace process.
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Last week, the Jerusalem Zoning Commission approved 930 new housing units in Har Homa. Actual building on the site is at least two years off.
Alongside its rare rebuke of a close ally, the State Department said Israelis and Palestinians should settle their differences on Jerusalem through negotiation.
"The United States is deeply concerned by continuing Israeli actions with respect to housing construction in Jerusalem," a State Department official said.
"We have raised this issue with the Israeli government and continue to make our position known. As we have said before, unilateral actions work against efforts to resume direct negotiations and contradict the logic of a reasonable and necessary agreement between the parties.
"We believe that through good-faith direct negotiations, the parties should agree on an outcome that realizes the aspirations of both parties for Jerusalem, and safeguards its unique religious status for people around the world. We will continue to press ahead with the parties to resolve the core issues in the context of a peace agreement."
Meanwhile, Chief Palestinian Negotiator Saeb Erekat condemned Israel's decision to build the housing units in Har Homa.
Erekat slammed the decision as illegal, adding that in pursuing the project, Israel was making clear "its intention to turn this occupation into an effective annexation."
EU Foreign Policy Chief Catherine Ashton also expressed her disapproval of Israel's decision, saying she was "profoundly disappointed" by Thursday's approval of the project.
"The European Union has repeatedly urged the government of Israel to immediately end all settlement activities in the West Bank, including in east Jerusalem. All settlement activities are illegal under international law," she added in a statement.
AP and AFP contributed to this report
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