Around 200 new homes are planned for the area, which lies between Abu Dis and Jabal al-Mukkabir, the Israeli daily Haaretz reported.
The settlement, referred to as Kidmat Zion, will be built on land purchased by Irving Moskowitz, a Florida businessman and patron of Jewish settlers.
Moskowitz also bought the landmark Shepherd Hotel in Sheik Jarrah, whose historic Palestinian owners — the Husseini family — lost a legal case to recognize their title to the property on Monday.
According to Haaretz, Mayor Nir Barakat took the settlement plans to three council members of the leftist Meretz party, and they threatened to withdraw from the coalition if he implements the plan.
The settlement “will split East Jerusalem in two and destroy any chance of dividing the city and of reaching a peace agreement,” Council member Meir Margalit said, according to the report.