The announcement by the office of Prime Minister Benjamin Netanyahu angered the Palestinians who said it would inflame tensions in the eastern sector of the city which has been plagued by almost daily clashes for the past four months.
"The government has decided to advance the planning of more than 1,000 units in Jerusalem -- roughly 400 in Har Homa and about 600 in Ramat Shlomo," a source in Netanyahu's office told AFP.
The source also confirmed Israel was to advance plans "for infrastructure projects in the West Bank," without giving further details.
The news emerged just weeks after hardline settlers took over 35 homes in Silwan, a densely populated Palestinian neighbourhood on the southern edge of the Old City, sparking fury in the West Bank city of Ramallah and condemnation from Washington.
And Jibril Rajoub, a senior member of Abbas's Fatah faction, warned it would likely fuel further violence.
"Such unilateral acts will lead to an explosion," he said just days after a 21-year-old Palestinian from Silwan rammed his car into a crowd of Israelis, killing an infant and a young woman.
"The Israelification of east Jerusalem is the most provocative act for us as Palestinians, as Muslims, as Christians, as Arabs," he said.
State Department spokeswoman Jen Psaki said Washington was "deeply concerned" by Israeli settlement plans.
"Israel's leaders have said they would support a pathway to a two-state solution, but moving forward with this type of action would be incompatible with the pursuit of peace," she said.
Palestinian news agency Wafa reported that Abbas had called for an emergency UN Security Council session over the east Jerusalem violence, as well as what he termed Israeli "aggression" at the nearby Al-Aqsa compound.
- The root cause -
"The root cause (of the ongoing unrest) is the Israeli occupation -- the frustration, the disappointment, losing hope in the future are all symptoms of what is going on on the ground," Rajoub said.
"Even the Americans have started to understand that Mr Netanyahu is responsible for what's going on."
Netanyahu denied Israel's actions in east Jerusalem had fuelled anger on the Palestinian street.
"The violence against us is not the result of construction in Jerusalem... it is because of our enemies' desire that we not be here at all," he said, pledging to crack down on the unrest until calm was restored to the city.
"You cannot build peace on a foundation of lies and illusions. And the root of this conflict always has been and always will be the refusal to recognise the Jewish state in any borders at all."
Over the weekend, police fired tear gas at hundreds of Palestinians at a "symbolic funeral" for the perpetrator of Wednesday's car attack, Abdelrahman Shaludi, who was shot by police as he fled and later died of his wounds.
The car attack sparked clashes between stone-throwers and police in Palestinian neighbourhoods which continued until Shaludi was buried late Sunday night under tight security restrictions, with the number of mourners restricted to 50.- 'Jerusalem is burning' -
Lior Amichai of Israeli settlement watchdog Peace Now also said the announcement on construction in Har Homa and Ramat Shlomo was likely to stir tensions.
"There is never a good time to do such things, now more than ever as Jerusalem is burning," he told AFP.
Israel seized east Jerusalem during the 1967 Six-Day War and later annexed it in a move never recognised by the international community. It views the city as its undivided capital and does not consider construction in the east as settlement building.
But for the Palestinians, who want east Jerusalem as capital of their future state, Israel's ongoing construction there is a major issue.
Israel's settlement policy was one of the main reasons for the collapse of the latest US-led round of peace talks in April, prompting the Palestinians to push ahead with diplomatic plans to seek international recognition.
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