Israeli authorities in Jerusalem on Sunday deferred for three days a debate on building permits that would create the largest Israeli settlement inside a Palestinian neighbourhood, city councillors said.

The council's planning and construction committee had been set to examine issuing permits for a settlement in the occupied east Jerusalem Palestinian neighbourhood of Jabel Mukaber, committee members told AFP.

They said the matter was now on the agenda for a Wednesday meeting, without giving reasons for the postponement.

Settlement watchdog Peace Now said it was because of a scheduling conflict concerning a lawyer for opponents to the scheme.

The permits, if granted, would allow for expansion of the Nof Zion settlement to add 176 housing units to the 91 existing units.

Plans for the new units have already been approved and issuing building permits is the last major bureaucratic step.

Peace Now and other NGOs say the approvals would make Nof Zion the largest Israeli settlement inside any Palestinian neighbourhood.

Most settlements, particularly in the occupied West Bank, are located outside of Palestinian residential areas.

"Within east Jerusalem, it's a very serious development," Peace Now spokeswoman Anat Ben Nun told AFP.

"It's indicative of a trend that we're seeing of settlement expansion inside Palestinian neighbourhoods in east Jerusalem."

Jerusalem's status is ultra-sensitive and central to the Israel-Palestinian conflict.

Israel occupied east Jerusalem in the 1967 Six Day War and later annexed it in a move never recognised by the international community.

It sees the entire city as its undivided capital, while the Palestinians want the eastern sector as the capital of their future state.

The Israeli government has announced several settlement expansions since US President Donald Trump took office.

Trump has been far less critical of Israeli settlement expansion than his predecessor Barack Obama.

Israeli settlements are seen as illegal under international law and major stumbling blocks to peace as they are built on land the Palestinians see as part of their future state.

Settlement watchdogs and Palestinians accuse far-right Israeli groups of pushing for settlements in east Jerusalem to ensure the city can never be divided.