JERUSALEM (AFP) - Israel on Saturday (Dec 15) welcomed Australia's recognition of west Jerusalem as its capital as "a step in the right direction", despite Canberra stopping short of moving its embassy to the city.

Australian Prime Minister Scott Morrison announced earlier on Saturday that his government was following US President Donald Trump's lead in recognising the contested city as Israel's capital.

But unlike the United States, he said Canberra would not relocate its Tel Aviv embassy to Jerusalem until Israel and the Palestinians reach a peace settlement.

In the meantime, Morrison said, Australia would establish a defence and trade office in the west of the city.

"Israel views the decision of the Australian government to open its trade and defence office in Jerusalem as a step in the right direction," a foreign ministry statement said.

"Israel congratulates the government of Australia for its stance regarding sanctions on Iran and also regarding its pro-Israel position at the UN and against antisemitism."

Israel occupied Arab east Jerusalem in the 1967 Six Day war and later annexed it, declaring the entire city its "eternal and indivisible capital."

Palestinians claim the eastern part as the capital of a future Palestinian state.

Senior Palestinian official Saeb Erekat said Australia's move to open a trade office in Jerusalem violates a United Nations resolution.

"From the beginning, we've perceived the Australian government's decision to recognise Jerusalem as Israel's capital as one wherein petty domestic politics steer irresponsible policies that contradict world peace and security," he said in a statement.

Most countries have avoided moving their embassies to anywhere in the city to avoid hindering peace talks on the city's final status - until Trump unilaterally moved the US embassy there earlier this year.

Unlike Trump, Morrison committed to recognising a future state of Palestine with east Jerusalem as its capital.