Israeli Housing Minister Uri Ariel has invited bids for 1,500 new homes in Jewish settlements in retaliation for a new Palestinian government backed by Hamas.
Of the new homes, 400 will be in Israeli-occupied east Jerusalem with the rest elsewhere in the occupied West Bank, the online edition of Haaretz newspaper reported.
"I congratulate the decision to give a proper Zionist response to the establishment of the Palestinian terror cabinet," the paper quoted Mr Ariel as saying.
"The right and duty of the state of Israel to build across the country to lower the housing prices is unquestionable, and I believe these tenders are just the beginning," said the minister, who is a member of the far-right Jewish Home party.
Palestinians demanded that the US take "serious steps" against Israeli settlement building.
"It is time for the American administration to take serious steps against what the government of Israel is doing," said Nimr Hammad, an adviser to president Mahmoud Abbas.
The announcement comes amid Israeli anger at its US ally's decision to work with the new merged administration for the West Bank and Gaza formed by Mr Abbas on Monday with the support of Hamas.
On a lightning visit to Israel's northern neighbour Lebanon, Secretary of State John Kerry defended the US decision.
He said it did not contradict US and European Union policy that bars all dealings with any Palestinian government involving Hamas until the Islamist movement renounces violence and recognises Israel.
Mr Kerry said Mr Abbas had "made clear that this new technocratic government is committed to the principles of non-violence, negotiations, recognising the state of Israel, acceptance of the previous agreements".
"Based on what we know now about the composition of this technocratic government, which has no minister affiliated to Hamas and is committed to the principles that I describe, we will work with it as we need to, as appropriate," the US top diplomat said.
The row over the new Palestinian government is further testing the once sacrosanct relationship between Israel and the United States, already strained by the collapse of US-brokered peace talks.
Mr Kerry, who invested huge political capital in the abortive negotiations, said Israel's persistent drive to expand the settlements played a major role in their failure.
The latest expansion announcement came as Palestinians marked the Nakba, or catastrophe, when Israel declared independence in 1948, displacing hundreds of thousands of people.
Much of the international community considers the building of Israeli settlements in the occupied territories illegal under international law.
