An additional $150m in aid will be transferred from the US to the Palestinian Authority. The US also called on other donor nations to increase aid.
The announcement was made by US Secretary of State Hillary Clinton in a video call with Palestinian PM Salam Fayyad.
Clinton said that despite deadlock, a “positive outcome” was still possible in the Middle East peace talks.
However she added that Israel’s plan for more settlement building in the West Bank was counterproductive.
The funding was described as an effort to shore up the Palestinian Authority’s budget and came after Israel said it planned to build more than 1,300 new homes for Jewish settlers in East Jerusalem. A move that sparkled widespread condemnation from the US, UN, European Union and Russia.
The US has rejected Israeli claims the new homes would not affect the peace process.
Speaking in the Indonesian capital, Jakarta, US president Obama said neither the Israelis nor the Palestinians were making the extra effort needed for a breakthrough in stalled peace talks.
He said Israeli settlement building was “never helpful when it comes to peace negotiations”.
“I’m concerned that we’re not seeing each side make the extra effort involved to get a breakthrough that could finally create a framework for a secure Israel living side by side in peace with a sovereign Palestine,” he added.
In a statement, Saeb Erekat, the chief Palestinian negotiator has urged the international community to recognise a Palestinian state in response to Israel’s latest plans to build the 1,300 new homes in the East Jerusalem settlements of Har Homa and Ramot.
“This latest unilateral Israeli act necessitates dramatic international action for immediate recognition of the Palestinian state [based] on the 4 June 1967 borders,” Erekat said.
On Tuesday, reports said a further 800 units were planned in the settlement of Ariel in the northern West Bank.
US Secretary of State Hillary Clinton is to meet Israeli Prime Minister Benjamin Netanyahu in New York on Thursday, and is expected to raise the issue of the settlements.