Israel began an operation to free 26 Palestian prisoners on Tuesday hours before the two sides were to hold new direct peace talks amid a growing row over settlements.

The 26 prisoners are the first batch of some 104 long-term detainees who are to be freed in stages as part of a US-brokered deal which brought Israel and Palestinians back to the negotiating table on July 30 for the first time in nearly three years.

But Wednesday's talks are likely to be overshadowed by Israel's advancement of plans to build thousands of new homes for Jewish settlers on lands the Palestinians want for a future state.

Despite the growing strains over the settlements, Israel pushed ahead with a pledge to release 26 long-term detainees with two busloads of detainees seen leaving Ayalon prison near Tel Aviv late on Tuesday, an AFP correspondent reported.

One bus carrying 15 prisoners set off for the Erez crossing at the northern entrance to the Gaza Strip, while the other headed towards the West Bank city of Ramallah.

Shortly afterwards, one of the buses was seen entering Israel's Ofer prison compound near Ramallah, another correspondent reported.

Inside, the 11 West Bank residents were to meet senior Palestinian officials, then be transferred to a Palestinian bus which would take them to the Muqataa compound of president Mahmud Abbas for a welcoming ceremony.

A spokesman for Israel Prisons Services earlier told AFP they would be held at Ofer and Erez until around 1:00 am (2200 GMT Tuesday) when they would be formally freed.

The prisoner release has been billed as a confidence building gesture ahead of Wednesday's meeting in Jerusalem which was expected to take place at the King David Hotel in the presence of US mediator Martin Indyk.

But tempers were fraying on Tuesday after Israel approved construction of nearly 1,000 new settler homes in annexed east Jerusalem, sparking Palestinian allegations that they were aimed at torpedoing the fledgling talks.

Yasser Abed Rabbo, a senior official in the Palestine Liberation Organisation, said that the announcement, coupled with the weekend approval of nearly 1,200 homes in east Jerusalem and elsewhere in the West Bank, threatened to bring about the "collapse" of the talks.

"This settlement expansion is unprecedented," he said. "It threatens to make talks fail even before they've started."

Jerusalem city council said the approval for the construction of 942 new homes in the city's eastern Arab sector had been granted on Monday but had been in the works for years.

Two days earlier, Israel's housing ministry announced tenders for the construction of 793 settlement housing units in annexed east Jerusalem and 394 elsewhere in the West Bank.

US Secretary of State John Kerry, whose dogged shuttle diplomacy nudged the sides to a preliminary meeting in Washington last month, said Abbas would not give up on the talks so easily.

Abbas "is committed to continuing to come to the negotiation because he believes that negotiation is what will resolve this issue," Kerry said on Tuesday on a visit to Brasilia.

Kerry said he did not expect the latest developments to become a "speed bump," but he reiterated that the United States regards all settlements as illegal.

The last round of direct talks broke down in September 2010 over Israel's settlement building policies.

Last week, Washington said the next round of talks would be held in Jerusalem on August 14, but so far, Israeli and Palestinian officials have remained tight-lipped about details of the meeting.

As the release of the prisoners neared, excited relatives were already gathering in Gaza City, setting up a welcoming tent and hanging flags on the streets, an AFP correspondent reported.

The remaining 78 prisoners will be freed in batches in the coming months, depending on progress in peace talks.

Earlier on Tuesday, Israel's Supreme Court rejected a last-minute appeal by families of victims, saying the move was a political decision for the government alone to take, court documents said.