Israeli Prime Minister Ehud Olmert on Sunday approved new construction in a West Bank settlement near Jerusalem, setting off another crisis in embattled peace negotiations ahead of the arrival of a key U.S. mediator.

The construction decision came as tempers flared in Jerusalem, three days after a Palestinian resident of the city shot and killed eight students at a rabbinical seminary, dampening already low expectations for peace negotiations that are aiming for a treaty yet this year.

Israeli Housing Minister Zeev Boim said the new building would include 350 apartments in Givat Zeev, a West Bank settlement just outside of Jerusalem, and 750 homes in Pisgat Zeev, a Jewish neighborhood in east Jerusalem, the section Israel captured and annexed in the 1967 Mideast war, now claimed by Palestinians as their capital.

Boim told Israel Radio that the Givat Zeev construction began eight years ago but was suspended because of fighting with the Palestinians.

"When violence subsided, demand grew again and contractors renewed their permits to build there," he said. The Pisgat Zeev construction, he added, "is inside Jerusalem's city borders." The Israeli annexation of east Jerusalem, including the Old City and its hotly contested holy sites, is not recognized internationally.

Palestinian negotiator Saeb Erekat condemned the new plans, saying they undermine already troubled peace efforts. "Why do they insist on doing this and humiliating Abu Mazen in front of the Palestinian public," he said, using the nickname of Palestinian President Mahmoud Abbas.

Erekat said he has appealed to the U.S. to pressure Israel to halt the projects. Palestinians charge that Israeli settlement expansion is sabotaging their efforts to build a state in the West Bank and Gaza Strip.

Olmert and Abbas promised U.S. President George W. Bush last November to work for a peace treaty this year, renewing negotiations that were frozen during seven years of violence. But the talks have already been interrupted several times because of arguments over Israeli construction in disputed areas.

The bloody Jerusalem attack added another negative layer to the already complex negotiations. Abbas had already suspended the talks because of Israel's Gaza offensive last week to try to stop daily Palestinian rocket barrages on southern Israel, agreeing to renew them only under direct pressure from U.S. Secretary of State Condoleezza Rice.

The seminary attack came just hours after Palestinians in Gaza set off a bomb on the border, killing two soldiers, a Bedouin and a Jew. The Jewish soldier, who died of his wounds Sunday, was buried in a funeral ceremony conducted partly in sign language, because both his parents are deaf.

On Thursday, a U.S. envoy, Lt. Gen. William Fraser III, is scheduled to arrive in the region for his first joint meeting with Israelis and Palestinians.

Bush appointed Fraser in January to monitor implementation of the U.S.-backed "road map" peace plan — which among other things calls on Israel to freeze all settlement activity. The plan also calls on the Palestinians to dismantle violent groups — a step Israel says has not been fulfilled.

The latest construction dispute involves three of the four main core issues that have defied solution in more than a decade of on-again, off-again peace negotiations — borders between Israel and a Palestinian state, Jewish settlements in the West Bank and the future of Jerusalem. The fourth issue is a solution for Palestinian refugees.

Givat Zeev is in one of the three major settlement blocs that Israel intends to retain in any peace agreement. Bush has signaled support for the Israeli position, and the Palestinians have expressed willingness to consider swapping land where settlement blocs stand for equal amounts of Israeli land.

Most of the 270,000 West Bank settlers live in the major blocs, and an additional 180,000 Israelis live in Jewish neighborhoods Israel built in east Jerusalem after 1967. Israel does not consider the east Jerusalem neighborhoods to be settlements, but the Palestinians and international community do.