The settlement lies near the barrier dividing Israelis and Palestinians
Israel says it is pushing ahead with delayed plans to build almost 500 more homes for Jewish settlers in Jerusalem.
The project is for the Pisgat Zeev settlement in annexed East Jerusalem, captured by Israel in the 1967 war.
The announcement comes two days after Israel said it would build 450 new homes for settlers in the West Bank.
The US has urged Israel to stop all settlement of occupied Palestinian land as part of efforts to re-start peace talks in the Middle East.
UN Secretary Ban Ki-moon expressed "deep concern" over Israel's announced intentions and reiterated his call on Israel to end all settlement building and dismantle outposts in Palestinian territory.
"Such actions and all settlement activity are contrary to international law and the roadmap," he said in a statement.
The Palestinian leadership says any future agreement to freeze new building in settlements is now worthless.
Tenders were first issued for the Pisgat Zeev project in 2008, but it was put on ice when the authorities rejected bids from developers as too low.
The land lies on Jerusalem's north-east boundary close to Palestinian communities and Israel's separation barrier.
A government spokesman said Israel was "willing to consider" curbs on settlement activity in the occupied West Bank, but stressed that this did not include Jerusalem.
Israel annexed East Jerusalem after the 1967 Arab-Israeli war and claims the whole city as its united capital.
International law holds that all settlement building on occupied land is illegal.
The European Union expressed "serious concern" over Israel's latest moves to expand settlements.
"The European Union reiterates its call on Israel to immediately end settlement activities, including in East Jerusalem," the EU said in a statement.
US envoy George Mitchell is due to return to the region later in the week.
Palestinian negotiator Saeb Erekat said the whole US diplomatic drive under the Obama administration was now in doubt.
"If you could not convince the Israelis to stop settlement activity, will anybody in the Arab and Islamic world believe you can make Israel return to the '67 borders or withdraw from settlements?" he said.