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Israel has made the first steps to legalise thousands of settler homes in the occupied West Bank, in defiance of international law.

This would mean that between 2,000 and 3,000 Jewish homes in the occupied territories would become legal under Israel law, but it requires three more full parliamentary votes to be passed.

There are hoped that the bill might stall with some backroom deals following the 58-50 vote in Knesset.

Prime Minister Benjamin Netanyahu initially opposed the bill, fearing an international backlash and legal implications, but voted in favour on Wednesday.

Netanyahu faces pressure to hold his right-wing coalition together and not be seen as moving against the powerful settler movement.

There has been speculation that the bill could even cause the government to collapse - though a number of analysts caution that a compromise seems more likely for now.

The bill has been pushed by hardline members of Netanyahu's coalition who defied his pleas not to move forward, while the country's attorney general said it will never hold up in court.

The Israeli outpost called Amona is home to 40 families and was subject to a high court order for its demolition by 25 December because it was built on private Palestinian land.

The bill however goes far beyond legalising Amona and would allow an estimated 2,000 to 3,000 Jewish homes in the West Bank built on Palestinian land to be legalised.

Palestinian landowners would be offered compensation in exchange, but Attorney General Avichai Mandelblit said the move would undermine private property laws.

US President Barack Obama's administration said it is "deeply concerned".

"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," State Department spokeswoman Elizabeth Trudeau said.

The international community considers all Israeli settlements in Israeli-annexed east Jerusalem and the West Bank to be illegal, whether they are authorised by the government or not.

The Israeli government differentiates between those it has approved and those it has not.

The progress of the bill, approved earlier by a committee of ministers on behalf of the government, has demonstrated the power of the settler movement.

Netanyahu's government is seen as the most right-wing in Israeli history, and key members of his coalition advocate annexing most of the West Bank while openly opposing the idea of a Palestinian state.

Opposition leader Isaac Herzog, who heads the Labour party, said the bill contravened Israeli and international law while justifying "theft."