Israel accelerated its illegal annexation of East Jerusalem last year through municipal and security policies that discriminated against Palestinian residents, an EU report said.

The internal report by European diplomats, dated Dec. 15, 2008, was obtained by Reuters as fresh controversy simmered over Israel's plan to demolish scores of Palestinian homes in East Jerusalem, part of territory occupied in 1967.

The number of building tenders issued by Israel for Jews in East Jerusalem increased by a factor of 40 in 2008 over 2007, the report said, while Israeli authorities placed severe restrictions on construction permits for Palestinians, who were also denied municipal funding proportionate to their population.

The report also criticised Israel for constructing a wall that runs through Jerusalem, saying it cut off thousands of Palestinians from the occupied West Bank.

The 20-page report acknowledged Israel's security needs but said its "actions in and around Jerusalem constitute one of the most acute challenges to Israeli-Palestinian peace-making".

Israel annexed East Jerusalem, a move condemned internationally. Palestinians want to found a state in the West Bank and Gaza with its capital in East Jerusalem.

The Jerusalem municipality said last month it planned to demolish 88 Palestinian homes in another section of Silwan, near the walls of Jerusalem's Old City, to create a "public garden."

U.S. secretary of state, Hillary Clinton, who visited the region this week, criticised Israel's plans to demolish dozens of Palestinian homes in Quds as a violation of its international obligations.

A U.S.-backed peace "road map" that has served as the foundation of Israeli-Palestinian talks calls for a halt to all Israeli settlement expansions.

Palestinians say there is a campaign to drive out Arab residents in occupied territories.

Reuters