They also sharply criticised a separate bill that would limit the volume of calls to prayers at mosques in Israel and occupied Jerusalem, a measure watchdogs have called a threat to freedom of religion and an unnecessary provocation.
A committee of Israeli ministers adopted the two bills on Sunday, though they must still be approved by parliament.
The settler bill had been pushed forward by Education Minister Naftali Bennett of the hardline Jewish Home party.
Bennett last week called for an end to the idea of a Palestinian state after Donald’s Trump’s election win in the United States.
“The recent Israeli measures are going to lead to catastrophe in the region,” said Nabil Abu Rudeina, spokesman for Palestinian president Mahmud Abbas.
“The Palestinian leadership will turn to the UN Security Council and all other international organisations to stop those Israeli measures.”
Palestinian foreign minister Riad al-Malki accused the Israeli government of seeking to “impose facts on the ground and create new realities by legalising the illegal actions that it commits.”
Israel’s long-time ally, the US, also condemned the bill, calling it an “unprecedented and troubling” step in a statement on Monday.
“This would represent an unprecedented and troubling step that’s inconsistent with prior Israeli legal opinion and also break longstanding Israeli policy of not building on private Palestinian land.”
“Our policy on settlements is clear. We believe they are corrosive to the cause of peace,” she added.
“This legislation would be a dramatic advancement of the settlement enterprise, which is already gravely endangering the prospects for a two-state solution.”
The bill to legalise Israeli homes in the West Bank was drafted in response to a court order requiring the Israeli outpost of Amona, which includes about 40 families, to be evacuated by December 25.
The bill would allow for the legalisation of settlement homes built on private Palestinian land in communities that meet certain criteria.
The Palestinian landowners would be offered compensation in return for the land being seized.
The bill is expected to apply to between 2,000 and 3,000 homes in the West Bank.
The Israeli government differentiates between those it has approved and those it has not. Settlements like Amona are considered outposts as they have not been given Israeli government approval.
Settlements are seen as a major stumbling blocks to peace efforts as they are built on land the Palestinians see as part of their future state.