Israel denies that the new homes are being built illegally
Israel's PM Benjamin Netanyahu has moved to ease tensions with the US, describing the two countries' relations as those of "allies and friends".
Mr Netanyahu also dismissed reports one of his confidants called US President Barack Obama a "disaster" for Israel.
The US has criticised the building of Jewish homes in East Jerusalem, which prompted the Palestinians to pull out of US-brokered indirect peace talks.
The row has caused one of the worst crises in US-Israeli ties for decades.
It has also led to increased tensions between Israel and the Palestinians.
On Saturday, Palestinian Authority President Mahmoud Abbas ruled out indirect "proximity" talks with Israel as long as it maintained its settlement policy in East Jerusalem and the West Bank.
A statement from the Arab League summit in Libya on Sunday said the resumption of Palestinian-Israeli negotiations required an end to all settlement building, including East Jerusalem.
But the body, which backed the proximity talks which had been due to begin as the US-Israeli row broke out, did not specify whether its latest statement was referring to direct or indirect talks.
Mr Abbas says talks cannot take place if Israel continues settlement building
A senior Palestinian official has told the BBC that to enter the proximity talks the Palestinians required assurances that the controversial Ramat Shlomo project for 1,600 homes, announced two weeks ago, would not be implemented for at least three years.
The Israelis must also not "continue to take actions which destroy our credibility", the official said.
Meanwhile, the US is reportedly considering abstaining from a possible UN Security Council resolution against Israeli settlement expansion in East Jerusalem. The US usually blocks Security Council resolutions criticising Israel.
US officials in Washington have not confirmed the report. It is likely that the US is considering how to maintain pressure, and a UN resolution would be one way, says BBC state department correspondent Kim Ghattas.
In the wake of a controversial visit to the US, Mr Netanyahu said on Friday that his policy on East Jerusalem would not change, despite US pressure on Israel to announce a freeze on building Jewish homes there.
A best-selling Israeli newspaper then quoted an unidentified aide as saying: "You could say that Obama is the greatest disaster for Israel - a strategic disaster."
But the prime minister, speaking before he briefed the cabinet on his US trip, condemned these comments as "unacceptable".
"They do not come from anyone representing me. The relations between Israel and the United States are those of allies and friends, and are based on tradition spanning many years."
Tension has also been mounting in Gaza in recent days, with two Israeli soldiers and two Palestinian militants reportedly killed in the worst clashes for more than a year.
At the cabinet meeting, Mr Netanyahu stressed that Israel would provide a "firm and decisive" response to any attack from the Palestinian militant group Hamas.
Israel pulled out in 2009 after an offensive which left hundreds of people dead.
Israel insists that Jerusalem will remain its undivided capital.
Nearly half a million Jews live in more than 100 settlements built since Israel's 1967 occupation of the West Bank and East Jerusalem.
They are considered illegal under international law, although Israel disputes this.
The Middle East quartet - the US, EU, UN and Russia - has called for final status negotiations to reach a comprehensive peace deal within two years.
POINTS OF TENSION IN JERUSALEM
1 Gilo: 850 homes approved for publication and planning objections in Nov 2009
2 Pisgat Zeev: 600 homes approved for publication and planning objections in Jan 2010
3 Sheikh Jarrah: Municipality approves the building of 20 new apartments on the site of an old hotel
4 Ramat Shlomo: 1,600 homes approved for publication and planning objections in Mar 2010
5 Silwan: Demolition orders on 88 Palestinian homes built without difficult-to-get permits - Israel planning controversial renewal project
6. West Bank barrier: Making Palestinian movement between West Bank and Jerusalem harder - Israel says it is for security