Israel's settlement construction in annexed east Jerusalem is part of a strategy aimed at preventing the Holy City from becoming the capital of two states, an internal EU report found on Wednesday.

In its Jerusalem Report 2012, the European Union said Jewish settlement construction posed "the biggest single threat to the two-state solution."

Describing Israel's settlement construction in east Jerusalem as "systematic, deliberate and provocative" the report accused the Jewish state of making deliberate political choices that threatened to render the two-state solution impossible.

Relations between Israel and the EU have been particularly tense in recent months, with Europe voicing increasing discontent over a raft of Israeli plans to build more than 5,000 new settler homes in and around annexed east Jerusalem.

The standoff has sparked Israeli concerns the 27-member bloc, its largest import and export market, could move to implement a series of punitive trade sanctions.

Authored by EU heads of mission in Jerusalem and Ramallah, the report flagged construction in three southern areas – Har Homa, Gilo and Givat HaMatos – as being the "most significant and problematic plans."

"The construction of these three settlements is part of a political strategy aiming at making it impossible for Jerusalem to become the capital of two states," it warned.

"If the current pace of settlement activity on Jerusalem's southern flank persists, an effective buffer between east Jerusalem and Bethlehem may be in place by the end of 2013, thus making the realization of a viable two-state solution inordinately more difficult, if not impossible."

The report also flagged Israel's decision to push forward with plans to build 3,426 units in E1.

AFP