The Palestinian Authority on Wednesday slammed Israel's approval of a key settlement project in the occupied West Bank, saying it undermined the chances of a two-state solution.

The approval of the project in the area known as E1"fragments... geographic and demographic unity, entrenching the division of the occupied West Bank into isolated areas and cantons that are disconnected from one another, turning them into something akin to real prisons," the PA's foreign ministry said in a statement.

Israel approved a major settlement project on Wednesday in an area of the occupied West Bank that the international community has warned threatens the viability of a future Palestinian state.

Israel has long had ambitions to build on the roughly 12-square-kilometre (five-square-mile) parcel known as E1 just east of Jerusalem, but the plan had been stalled for years amid international opposition.

Critics say the settlement would effectively cut the West Bank in two, undermining hopes for a contiguous Palestinian state with east Jerusalem as its capital.

Last week, Israel's far-right Finance Minister Bezalel Smotrich backed plans to build some 3,400 homes on the ultrasensitive tract of land, which lies between Jerusalem and the Israeli settlement of Maale Adumim.