The freeze - imposed while the government assesses all its building needs - drew the wrath of Jewish settlers, who described it as 'a declaration of war'.
The announcement was clearly designed to persuade James Baker, the US Secretary of State, to start handing over to Israel the dollars 10bn in loan guarantees when he visits Jerusalem on Sunday. The loan guarantees were held back because of the previous Israeli government's settlement drive, which pushed the Jewish population in the occupied territories to about 100,000.
Until the victory of the Labour government three weeks ago, Washington's stated position on settlements was to demand a total and permanent freeze.
According to diplomatic sources, since the victory of the new Labour government, which is more positive about peace, the US will no longer insist on a blanket halt to building. Mr Baker will come to Jerusalem prepared to 'negotiate' with Yitzhak Rabin, the Prime Minister, about how much building should stop and where.
Palestinian leaders are certain to accuse the US of betrayal if it gives an inch on the demand for a total ban, and they may threaten not to enter a new round of peace talks. However, it is understood that the US has already decided not to insist on a halt to building in the Jordan Valley or in east Jerusalem, and may be ready to allow some building to continue in other areas, deemed by Mr Rabin to be necessary for security reasons.
The negotiation between Mr Rabin and Mr Baker about what should be halted will centre on Mr Rabin's distinction between 'political' settlements, which he is prepared to halt, and those necessary for security reasons, which he says must be 'enhanced'. His explanations of the 'political' and 'security' distinction have been vague and contradictory.
According to a report in yesterday's Jerusalem Report magazine, Mr Rabin's definitions would allow an end to building in about 100 of the 140-odd settlements in the West Bank and Gaza Strip.
But Western diplomats are bracing themselves for a much less generous offer. In what diplomatic sources describe as their 'worst-case scenario' Mr Rabin will offer to halt building permanently in fewer than half the settlements in the West Bank and Gaza.
The Labour leader has spoken of the need to continue building along the 'confrontation lines' and in 'greater Jerusalem'. But he has not described what he means by either.
It is clear he includes the Jordan Valley and the Golan Heights as 'confrontation lines'. But Mr Rabin has been unclear about whether he also includes the old Green Line between the West Bank and Israel. If he does include the Green Line several large settlements which run near it will be spared the freeze - along with the 25 settlements in the Jordan Valley and the handful in the Golan Heights.
The worst case also assumes that Mr Rabin is taking a very broad interpretation of 'greater Jerusalem'. Experts believe that Mr Rabin may believe that it now extends several kilometres beyond the municipal boundary.