* Europeans suggest Netanyahu govt's credibility at risk
* Israel denies plan is response to Palestine's UN upgrade
Britain and France condemned on Saturday a plan by Israel to expand settlements in the occupied West Bank and East Jerusalem, saying international confidence in its desire to make peace with the Palestinians was at risk.
Stung by a UN vote according de facto recognition to a Palestinian state, Israel on Friday said it would build thousands of new settler homes, including in a wedge zone between Jerusalem and the West Bank, known as E1, which Washington considers especially sensitive.
The United States, one of just eight countries to vote alongside Israel against the Palestinians at the U.N. General Assembly, said the latest expansion plan was counterproductive to any resumption of direct peace talks stalled for two years.
France, which voted with the Palestinians, and Britain, which abstained, had tougher censure for Israel, which wants to keep all of Jerusalem and swathes of West Bank settlements under any future peace accord. Most powers view the settlements as illegal for taking in land captured in the 1967 Middle East war.
"If implemented, these plans would alter the situation on the ground on a scale that makes the two-state solution, with Jerusalem as a shared capital, increasingly difficult to achieve," British Foreign Secretary William Hague said in a statement.
"They would undermine Israel's international reputation and create doubts about its stated commitment to achieving peace with the Palestinians."
Hague's French counterpart, Laurent Fabius, spoke of E1 as "the new colonisation zone" and said the Israeli expansion plan could "drain the confidence needed for a return to dialogue".
"I call upon the Israeli authorities to abstain from any decision in this direction and to manifest clearly their desire to restart negotiations," Fabius said in a statement.
Israel says Thursday's upgrade of the Palestinians' status at the United Nations to "non-member state" from "entity" could allow them to sidestep disputes such as territorial demarcation that should be addressed in negotiations.
The Israelis were further incensed by what they deemed an inflammatory U.N. speech by Palestinian President Mahmoud Abbas, and said the upgrade resolution neglected the Jewish state's security and need for its own sovereignty to be recognised.
Abbas also claims the Palestinian sovereignty in Gaza, but the coastal strip is ruled by rival Hamas Islamists who are deeply hostile to the Jewish state and fought an eight-day war against it last month.
The Israeli settlement plan was disclosed to the media by officials in Prime Minister Benjamin Netanyahu's conservative government who spoke on condition of anonymity, a reticence suggesting the expansion had not been formally finalised.
Asked about the plan on Israel's Channel 2 television on Saturday, Deputy Foreign Minister Danny Ayalon denied it was in response to the Palestinians' U.N. upgrade.
"We are building, and we will continue to build, in accordance with our interest, not in accordance with the reaction of anyone else," Ayalon said.
Interviewed separately on Channel 2, Palestinian Prime Minister Salam Fayyad said that, if implemented, the Israeli settlement plan would be "most detrimental" to peace prospects.
"The challenge to all of us now is to use what happened two days ago (U.N. upgrade), to build on it, rather than spend too much time either, you know, thinking 'This is the end of the road', which it isn't, from our point of view, or continue to sulk about it and express protestation and anger," he said.