Israel angered the US by announcing the move during a visit by Vice-President Joe Biden aimed at backing peace talks.
US Secretary of State Hillary Clinton last week asked Israel to show it was committed to Middle East peace efforts.
But PM Benjamin Netanyahu rejected any limits on Jewish building in Jerusalem and has yet to respond to US concerns.
Speaking to Israel's parliament, the Knesset, Mr Netanyahu said he wanted peace negotiations, and hoped the Palestinians would not present "new preconditions" for talks.
"No government in the past 40 years has limited construction in neighbourhoods of Jerusalem," he said.
"Building these Jewish neighbourhoods in Jerusalem does not hurt the Arabs of East Jerusalem or come at their expense."
Palestinian leaders say indirect peace talks with Israel that US mediators had worked to set up are now "doubtful".
US state department spokesman Philip Crowley said the plans for US Middle East envoy George Mitchell, who was due to fly to the region this week, were in flux.
He did not go into detail about the "specific concerns" Mrs Clinton had raised in a long phone call to Mr Netanyahu on Friday.
But he stressed that Israel was "a strategic ally of the US and will continue to be so".
Earlier on Monday, Israel's ambassador to the US, Michael Oren, was quoted by Israeli media as saying ties between the two countries were at their lowest point for 35 years, since 1975.
He reportedly told a conference call with Israeli consuls general in the US at the weekend that "the crisis was very serious and we are facing a very difficult period in relations".
US-Israeli relations were strained in 1975 by a demand from then US Secretary of State Henry Kissinger that Israel's Prime Minister Yitzhak Rabin partially withdraw its troops from the Sinai Peninsula, where they had been since the 1967 Six-Day War.
Talks 'endangered'
The EU, as part of the Middle East Quartet, has already condemned Israel's decision to build new homes in East Jerusalem.
Speaking to Arab League members in Cairo on Monday, EU foreign policy head Baroness Ashton said the move had "endangered and undermined the tentative agreement to begin proximity talks".
She added: "The EU position on settlements is clear. Settlements are illegal, constitute an obstacle to peace and threaten to make a two state-solution impossible."
On Sunday, a top aide to US President Barack Obama said Israel's announcement of plans to build new homes in East Jerusalem during Mr Biden's visit was "destructive" to peace efforts and an "insult" to the US.
Just hours before the announcement, Mr Biden had emphasised how close relations were, saying there was "no space" between Israel and the US.
Under the Israeli plans, the new homes will be built in Ramat Shlomo in East Jerusalem.
The Palestinians are threatening to boycott newly agreed, indirect talks unless the Ramat Shlomo project is cancelled.
Close to 500,000 Jews live in more than 100 settlements built since Israel's 1967 occupation of the West Bank and East Jerusalem.
The settlements are considered illegal under international law, although Israel disputes this.
