The British and US governments and the United Nations have denounced plans approved by Israel to build 900 homes in Gilo, a neighbourhood in Jerusalem.
The building has been approved by the Israeli Interior Ministry has approved the expansion of the neighbourhood in south west Jerusalem.
A Foreign Office spokeswoman said: "The Foreign Secretary has been very clear that a credible deal involves Jerusalem as a shared capital. Expanding settlements on occupied land in East Jerusalem makes that deal much harder. So this decision is wrong and we oppose it."
Israel government spokesman Mark Regev said that Gilo was an essential part of developing Jerusalem.
"The Prime Minister is willing to adopt the policy of the greatest possible restraint concerning growth in the West Bank, but this applies to the West Bank. Jerusalem is Israel's capital and will remain as such," Mr Regev told Reuters.
The project, which will consist of four and five-bedroom apartments, is unlikely to be built for three to four years and members of the public can still raise objections to the planning decision.
White House spokesman Robert Gibbs said the US government was dismayed by the decision of the Jerusalem Planning Committee.
He said: “Neither party should engage in efforts or take actions that could unilaterally pre-empt, or appear to pre-empt, negotiations.”
A spokeswoman for UN Secretary General Ban Ki-Moon said: “This decision will undermine efforts for peace and cast doubt on the viability of the two-state solution."