Israeli plans to announce plans for construction beyond the Green Line next week, soon after the release of a third group of Palestinian security prisoners.
"There will be very little understanding from the European governments to any announcement of construction in the disputed territories," the EU diplomat said on Thursday.
Wasil Abu Yousif, a Palestinian official, said the expected announcement is evidence that Israel is "not serious" about pursuing peace.
"It's clear to everyone now that the Israeli government is killing the peace process."
While stopping short of threatening to withdraw from the current round of peace negotiations, he said Israel's policy would force the Palestinians to seek "more substantial alternatives."
Israeli construction in the occupied West Bank and east al-Quds (Jerusalem) has been a major source of tension in Mideast peace efforts.
More than 550,000 Israelis live among 2.5 million Palestinians in these areas, raising fears that the growing numbers will soon reach a point of no return that will make it impossible to partition the land.
For years, the Palestinians refused to negotiate with Israel while settlement construction continued, saying it was a sign of bad faith. But under heavy US pressure, the Palestinians reluctantly agreed to resume talks with the Tel Aviv regime last summer.
Under a US-brokered package, Israel agreed to release 104 long-serving Palestinian prisoners in four stages. Next week's release would be the third stage.
While Israel did not agree to halt settlement construction, Secretary of State John Kerry has urged restraint. During one visit to Israel, he questioned Israel's commitment to peace in light of the ongoing construction. Because of the Christmas holiday, there was no immediate American reaction Wednesday.
The international community considers Israeli settlements to be illegal or illegitimate. The European Union said last week it had asked Israel not to announce new construction in connection with the prisoner release, warning Israel would be held responsible for a resulting failure in peace talks.
The Israeli official said Israel is "strictly abiding by understandings reached in the framework of this round of negotiations."
The talks are scheduled to last for nine months, until late April, with the goal of reaching a "framework" agreement.
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