JERUSALEM (Reuters) - Israel rejected concerted criticism from the United States and Europe on Monday over Prime Minister Benjamin Netanyahu's decision to expand settlement building after the United Nations' de facto recognition of Palestinian statehood.
Washington urged Israel to reconsider its plan to erect 3,000 more homes in the occupied West Bank and East Jerusalem, saying the move hindered peace efforts with the Palestinians.
Britain, France, Spain, Sweden and Denmark summoned the Israeli ambassadors in their capitals to give similar messages.
An official in Netanyahu's office said Israel would not bend. "Israel will continue to stand by its vital interests, even in the face of international pressure, and there will be no change in the decision that was made," the official said.
Angered by the U.N. General Assembly's upgrading on Thursday of the Palestinians' status in the world body from "observer entity" to "non-member state", Israel said the next day it would build the new dwellings for settlers.
Such projects, on land Israel captured in a 1967 war, are considered illegal by most world powers and have routinely drawn condemnation from them. Approximately 500,000 Israelis and 2.5 million Palestinians live in the two areas.
In a shift that raised the alarm among Palestinians and in world capitals, Netanyahu's pro-settler government also ordered "preliminary zoning and planning work" for thousands of housing units in areas including the "E1" zone east of Jerusalem.
Such construction in the barren hills of E1 has never been put into motion in the face of opposition from Israel's main ally, the United States. Building in the area could bisect the West Bank, cut off Palestinians from Jerusalem and further dim their hopes for a contiguous state.
Israeli television stations reported Jerusalem's district planning commission would soon approve plans for several thousand more housing units, including more than 1,000 Israel had shelved two years ago after angering Washington by publishing the plans before a visit by Vice President Joe Biden.
The settlement plan, U.N. Secretary-General Ban Ki-moon said, would deal "an almost fatal blow" to a two-state solution to the Israeli-Palestinian conflict.
French President Francois Hollande said he was "extremely concerned" and Washington made clear it would not back such Israeli retaliation over the U.N. vote, sought by Palestinians after peace talks collapsed in 2010 over settlement building.
"We urge Israeli leaders to reconsider these unilateral decisions and exercise restraint as these actions are counterproductive and make it harder to resume direct negotiations to achieve a two state solution," White House spokesman Jay Carney told a briefing.
Ahead of a Netanyahu visit this week, Germany, considered Israel's closest ally in Europe, urged it to refrain from expanding settlements, and Russia said it viewed the Israeli moves with serious concern.
Israeli Finance Minister Yuval Steinitz said Israel could not have remained indifferent to the Palestinians' unilateral move at the United Nations.
"I want to tell you that those same Europeans and Americans who are now telling us 'naughty, naughty' over our response, understand full-well that we have to respond, and they themselves warned the Palestinian Authority," he said.
Palestinian chief negotiator Saeb Erekat said building in E1 "destroys the two-state solution, (establishing) East Jerusalem as the capital of Palestine and practically ends the peace process and any opportunity to talk about negotiations in the future".
The United States, one of the eight countries to vote alongside Israel against the Palestinian resolution at the General Assembly, has said both were counterproductive to the resumption of direct peace talks.
In Europe, only the Czech Republic voted against the status upgrade while many countries, including France, backed it. Netanyahu plans to visit Prague this week to express his thanks.
In the Gaza Strip, Sami Abu Zuhri, spokesman for the governing Hamas Islamist movement, called the settlements "an insult to the international community, which should bear responsibility for Israeli violations and attacks on Palestinians".
Israeli police arrested three Jewish settlers on Monday whom they suspect of arson and other crimes against Palestinian property in the West Bank, including the torching of a car.
Attackers have often proclaimed they are exacting a "price tag" for steps taken against the settler movement by Palestinians, or by the Israeli government.
Alongside the settlement plans, Israel announced it would withhold about $100 million in Palestinian tax revenues from the Palestinian Authority, which exercises limited self-rule in the West Bank, saying Palestinians owed $200 million to Israeli firms.
"These are not steps towards peace, these are steps towards the extension of the conflict," Spanish Foreign Minister Jose Manuel Garcia-Margallo said.
Only three weeks ago, Netanyahu won strong European and U.S. support for a Gaza offensive that Israel said was aimed at curbing persistent cross-border rocket fire.
Favored by opinion polls to win a January 22 national election, he brushed off the condemnation and complaints at home that he is deepening Israel's diplomatic isolation.
Netanyahu told his cabinet on Sunday that his government "will carry on building in Jerusalem and in all the places on the map of Israel's strategic interests".
But while his housing minister has said the government would soon invite bids from contractors to build 1,000 homes for Israelis in East Jerusalem and more than 1,000 in West Bank settlement blocs, the E1 plan is still in its planning stages.
"No one will build until it is clear what will be done there," the minister, Ariel Attias, said on Sunday.
Israel froze much of its activities in E1 under pressure from former U.S. President George W. Bush, and the area has been under the scrutiny of his successor, Barack Obama.
Israel cites historical and Biblical links to the West Bank and Jerusalem and regards all of the holy city as its capital, a claim that is not recognized internationally.
(Additional reporting by Crispian Balmer, Dan Williams, Nidal al-Mughrabi in Gaza, Jihan Abdalla in Ramallah, Steve Gutterman in Moscow, Gareth Jones in Berlin, John Irish and Elizabeth Pineau in Paris and Tim Castle in London; writing by Jeffrey Heller; editing by Philippa Fletcher)