The United States has called on Israel to "reconsider" a decision to allow 3,000 more homes for Jewish settlers in East Jerusalem and the occupied West Bank.
White House spokesman Jay Carney said Israel should "exercise restraint" and called the move "counterproductive" for a resumption of direct negotiations.
Earlier, the Israeli ambassadors in Paris, Stockholm, and London were called in to hear official complaints regarding the decision.
Germany also urged Israel to refrain from expanding Jewish settlements in the West Bank.
The diplomatic protests follow United Nations Secretary-General Ban Ki-moon's warning that the new settlements would be an "almost fatal blow" to peace prospects.
A UN statement said the building project would risk "completely cutting off" East Jerusalem from the rest of the West Bank.
Israel’s building announcement on November 30 came one day after the UN General Assembly overwhelmingly voted to upgrade the Palestinians’ UN status from "observer entity" to "nonmember state."
Israel intensified the pressure on December 2, with the cabinet announcing it was withholding from the Palestinians some $100 million in taxes and other revenues that Israel collects on behalf of the Palestinian Authority.
In another development, Palestinian National Authority President Mahmud Abbas returned to the West Bank from the United Nations in New York and declared: “Now we have a state.”
"Congratulations to all of you brave Palestinians -- you alone have accomplished this achievement and alone have won this victory," Abbas said.
Abbas pledged to now turn his attention to achieving reconciliation between Palestinians.
This was a reference to the split between the two main Palestinian political factions – Abbas’s Fatah, which governs the West Bank, and the Islamist movement Hamas, which rules the Gaza Strip.
Hamas militants, who say they seek Israel’s destruction and frequently fire missiles at Israel, are not regarded as possible peace partners by Israel or its ally the United States.
In his statement criticizing Israel’s building plan, UN chief Ban said, “Settlements are illegal under international law.” He said that should the Israeli plan be carried out, “it would represent an almost fatal blow to remaining chances of securing a two-state solution."
Speaking at a cabinet meeting on December 2, Prime Minister Benjamin Netanyahu brushed off the criticism, vowing that Israel would continue to build in Jerusalem.
Israel considers all of Jerusalem, including the eastern part that Palestinians want for a capital, to be Israel’s capital.
"Today we are building and we will continue to build in Jerusalem and in all areas that are on the state of Israel's map of strategic interests," Netanyahu said.
The Israeli cabinet declared that last week's UN vote upgrading the Palestinians' recognition would have no influence on any future negotiations between Israel and the Palestinians.
Concerning the withholding of tax funds due the Palestinians, Israeli Finance Minister Yuval Steinitz said the money would instead be used to pay down the Palestinian Authority's debt to the Israeli electricity company and other Israeli entities.
Yasser Abed Rabbo, a senior Palestinian official, condemned the Israeli confiscation of the tax funds as "piracy and theft.”
Palestinians say the monthly tax transfers from Israel are crucial for the cash-poor Palestinian Authority to pay salaries to tens of thousands of government employees and security forces.
With reporting by Reuters, AP, AFP, and dpa