JERUSALEM (AFP) - In a confidential report obtained by AFP on Thursday, the European Union accused Israel of actively pursuing the annexation of Arab east Jerusalem and undermining hopes for peace with Palestinians. The annual report drafted by the EU heads of missions in Jerusalem accused Israel of implementing in 2009 an intricate policy which includes expanding Jewish settlements and demolishing Palestinian homes in east Jerusalem. Developments in east Jerusalem in 2009 were marked by the continued expansion of Israeli settlements and a considerable number of Palestinian house demolitions and eviction orders, said the report, published first by Israels liberal Haaretz daily. Israel occupied and annexed east Jerusalem in 1967 and considers it its eternal indivisible capital in a move never recognised by the international community. Israel is, by practical means, actively pursuing its illegal annexation of east Jerusalem by weakening the Palestinian community in the city, impeding Palestinian urban developments and ultimately separating east Jerusalem from the rest of the West Bank. The future of east Jerusalem, which the Palestinians want to make the capital of their promised state, is one of the most sensitive issue in Middle East peace talks, which have been suspended for almost a year. The EU report said that the Jewish states policies in east Jerusalem are undermining prospects for a Palestinian capital in east Jerusalem and incrementally render a sustainable two-state solution unfeasible. The 14-page report dated November 23 said that Israels policy in east Jerusalem is an integral part of a broader Israeli strategy. It goes on to accuse the Israeli government and Jerusalem municipality of supporting and assisting private right-wing Jewish organisations of strengthening the Jewish hold in and around the Old City. The continued settlement expansion plans around the Old City effectively encircles and contains the historic basin and separates the Muslim holy places from the rest of east Jerusalem, the report said. It said the municipality places severe restrictions on issuing building permits for Palestinian houses in east Jerusalem, forcing them to construct without permits. As a result, over 600 Palestinian-owned structures have been demolished since the year 2000, it said. Last week, Israeli Prime Minister Benjamin Netanyahu announced a freeze on new permits for house construction in Jewish settlements in the rest of the West Bank, but the decision does not affect east Jerusalem, where some 200,000 Jews live in 12 settlements. Foreign ministry spokesman Yigal Palmor branded the report as dishonest. This report is based exclusively on Palestinian versions and figures. It reflects the Palestinian propaganda, he told AFP.