Prime Minister Benjamin Netanyahu rejected on Monday any halt on Jewish settlement in and around Jerusalem, defying Washington in Israel's deepening crisis with U.S. President Barack Obama's administration.

"For the past 40 years, no Israeli government ever limited construction in the neighbourhoods of Jerusalem," he said in a speech in parliament, citing areas in the West Bank that Israel captured in a 1967 war and annexed to the city.

The United States has condemned Israel's plan to build 1,600 new homes for Jews in Ramat Shlomo, a religious settlement in occupied Jerusalem.

Israel's announcement of the project during a visit last week by U.S. Vice President Joe Biden embarrassed the White House. U.S. Secretary of State Hillary Clinton, in unusually blunt remarks, called it an insult.

The Palestinians, who had just agreed to begin indirect peace talks under U.S. mediation, said they would not go ahead unless the plan was scrapped. Israel has said construction at the site would not begin for several years.

In parliament, Netanyahu, who heads a coalition that includes pro-settler parties, including his own, said there was nearly total consensus in Israel that occupied areas of Jerusalem would be "part" of the Jewish state in any future peace deal.

He made the comments -- signalling to Washington he believed he had political backing at home to withstand pressure over Jerusalem -- after Israeli media said Clinton had demanded the decision to build in Ramat Shlomo be reversed.

On Sunday, Netanyahu tried to play down what his envoy to Washington was reported to have described as a "crisis of historic proportions", voicing regret at a cabinet meeting for the timing of the Ramat Shlomo project's announcement.

In the West Bank city of Ramallah, Nabil Abu Rdainah, an aide to Palestinian President Mahmoud Abbas, responded to Netanyahu's comments at the parliamentary session by pledging again not to return to peace talks until settlement was halted.

Abbas had voiced that demand in resisting U.S. calls to revive negotiations suspended since December 2008 but agreed last week to indirect talks after receiving backing from the Arab League and the Palestine Liberation Organisation.

Obama's Middle East envoy, George Mitchell, was expected to return to the region later this week.

Some 2.5 million Palestinians live in the West Bank and East Jerusalem, which was also captured by Israel in 1967. There are about 500,000 Jews in the same areas.

Reuters