Israel says the new homes are the natural growth of existing communities
US Secretary of State Condoleezza Rice warned Jewish settlement building was having a "negative effect" on efforts to forge a Middle East peace deal.
Ms Rice was referring to Israeli plans to build 1,300 new homes in Ramat Shlomo, an area of the West Bank that Israel considers part of Jerusalem.
She also said militants must stop firing rockets at Israel from Gaza.
She spoke after meeting Israeli PM Ehud Olmert in Jerusalem and Palestinian leader Mahmoud Abbas in the West Bank.
The Palestinians have called the settlement plans a systematic policy to destroy the peace process.
Israel has described the new homes as the natural growth of existing communities.
After meeting Palestinian Authority President Mr Abbas in Ramallah, Ms Rice said: "It's important to have an atmosphere of trust and confidence.
"Unfortunately, I do believe, and the United States believes, that the actions and the announcements that are taking place are indeed having a negative effect on the atmosphere for negotiations."
Asked if she expected Israel to take action to rein in settlement activity, the secretary of state said: "I don't expect, frankly, any blinding breakthroughs."
The Israeli prime minister's spokesman told reporters: "It's clear to everyone the Jewish neighbourhoods of Jerusalem will remain part of Israel in any possible final status agreement."
Dr Rice is on her sixth peace-finding mission to the Middle East this year
Ms Rice also said she saw no reason why Israel had not yet approved travel papers for Palestinian students from Gaza who won scholarships to study in the US.
The students had been told by US diplomats that they could not use their fellowships this year because Israel did not approve visas - until the US secretary of state intervened.
"I consider it extremely important for these young people to be able to take up their fellowships," she said.
Israel has been accused of violating a commitment to halt all settlement activity under a 2003 US-backed "road map" peace plan, which also called on the Palestinians to clamp down on militants.
On Monday, Ms Rice is expected to discuss road map compliance at talks with Israeli Defence Minister Ehud Barak and Palestinian Authority Prime Minister Salam Fayyad.
She is on her sixth trip to the region this year to try to prod both sides toward a peace deal by the end of 2008, before President George W Bush leaves office.
The Palestinians claim all of the West Bank as part of a future independent state, with east Jerusalem as its capital.
But Israel considers all of Jerusalem - including the eastern part which it captured in a 1967 war - to be its "eternal and indivisible" capital.