The United States has voiced rare criticism of Israel, for its decision to build more homes on occupied land.
"This doesn't help build confidence," Secretary of State Condoleezza Rice said after meeting Israeli foreign minister Tzipi Livni in Brussels.
Israel said on Tuesday it had invited bids to build 300 new homes in Har Homa, a settlement in East Jerusalem. The Palestinians asked the US for help.
Israel says it annexed the area in 1967 and so does not regard it as occupied.
However, the Palestinians say Israel is trying to encircle the capital of a future Palestinian state.
Ms Rice recalled last week's Middle East peace conference in Annapolis - a planned step towards relaunching the long-dormant Middle East peace process.
"We are in a time when the goal is to build maximum confidence with the parties, and this doesn't help to build confidence," she told journalists.
She added: "It's even more important now that we are on the eve of the beginning of the negotiations. I made that position clear."
The UN secretary-general, Ban Ki-Moon, also criticised the project, and a top Palestinian official, Nabil Abu Rdainah, had urged Washington to act now.
"Asking them to explain is not enough," he said. "The Americans must pressure the Israeli government to stop settlement activities."
Israel argues that the homes are part of plans drawn up seven years ago, and that the area - known in Arabic as Abu Ghneim - is in any case not covered by the United States' roadmap to peace.
Israeli and Palestinian negotiators are due to meet on Wednesday for the first time since the Annapolis meeting.
Correspondents say the US administration wants the Middle East peace talks to conclude before President Bush steps down in 13 months.
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