The United States has voiced its "dismay" over Israel's approval of 900 additional housing units at a Jewish settlement in East Jerusalem, BBC reported.
White House spokesman Robert Gibbs said the move makes it "more difficult" to revive Israeli-Palestinian peace talks.
He was speaking shortly after planning applications for the new units had been approved by Israel's interior ministry.
The planning and construction committee authorised the expansion of Gilo, which is built on land captured in 1967.
The land was later annexed to the Jerusalem municipality.
With the project yet to be reviewed, the public can still make objections.
Settlements on occupied territory are considered illegal under international law, though Israel disputes this.
Netanyahu is showing again that he is spoiling any chance to start negotiations by continuing to create new provocations in Jerusalem
Hagit Ofran, Peace Now
It is the second time in two months that the Obama administration has spoken out on settlements.
In September the White House said it regretted reports that Israel planned to approve new construction in the West Bank.
The BBC's Paul Adams in Washington says the conventional wisdom in the US is that Israeli Prime Minister Benjamin Netanyahu has successfully thwarted Barack Obama's first foray into the stalled Middle East peace process, rebuffing American calls for a complete settlements freeze.
But some Washington observers say it's too early to write off the president's efforts, he says.
They believe Mr Obama is playing a long game and that the frosty relations between Mr Netanyahu and the White House could cause problems for the Israeli leader in the future, our correspondent adds.
'Israel's capital'
Israeli media reported earlier that the government had rejected a request from Washington to freeze the construction work at Gilo.
State department spokesman Ian Kelly said the planning decision was dismaying
Mr Obama's Middle East envoy, George Mitchell, is said to have made the request to Mr Netanyahu at a meeting in London on Monday.
Mr Netanyahu replied that the project did not require government approval and that Gilo was "an integral part of Jerusalem", according to Israel Army Radio.
His spokesman, Mark Regev, declined to comment on the reports, but repeated Israel's refusal to include areas annexed to Jerusalem as part of any accommodation of Mr Obama's call for "restraint" in settlement construction.
"Prime Minister Netanyahu... is willing to adopt the policy of the greatest possible restraint concerning growth in the West Bank, but this applies to the West Bank," he told the Reuters news agency. "Jerusalem is Israel's capital and will remain as such."
Palestinian anger
The Palestinian Authority has demanded a halt to all settlement construction before it will attend new peace talks, which were suspended last year.
Mr Gibbs said: "We are dismayed at the Jerusalem Planning Committee's decision to move forward on the approval process for the expansion of Gilo in Jerusalem.
Map showing Gilo
"Neither party should engage in efforts or take actions that could unilaterally pre-empt, or appear to pre-empt, negotiations."
America's position, he added, was that the status of Jerusalem must be resolved "through negotiations between the parties".
The BBC's Tim Franks in Jerusalem says Tuesday's announcement represents by far the largest batch of planning approvals for building on occupied territory since Mr Netanyahu became prime minister.
The 900 housing units, which will be built in the form of four-to-five-bedroom apartments, will account for a significant expansion of Gilo. The interior ministry said construction work would be unlikely to start for another three or four years, once the plans gained final authorisation.
A spokesman for Palestinian Authority President Mahmoud Abbas said the planning approval was "yet another step that shows and proves Israel is not ready for peace".
"This step will ruin every single attempt - European or American - to preserve the peace process," Nabil Abu Rudeineh said.
Israel's Peace Now movement, which opposes Jewish settlement activity, said Mr Netanyahu was "showing again that he is spoiling any chance to start negotiations by continuing to create new provocations in Jerusalem".
"This development is intended to torpedo progress that is taking place between US and Palestinians and Israelis on renewing the talks," said Peace Now's Hagit Ofran.
Nearly 500,000 Jews live in more than 100 settlements built on occupied territory in the West Bank and East Jerusalem.