JERUSALEM (REUTERS) - A woman who was in a crowd that was rammed by a Palestinian's car in Jerusalem on Wednesday died of her injuries on Sunday, raising the death toll to two from what the police called a terrorist attack.

Police identified the woman as Luba Samri, a 22-year-old tourist from Ecuador. The other victim was a three-month-old baby, a US citizen.

The incident has inflamed tensions between Israelis and Palestinians in the holy city that both see as their capital, with Prime Minister Benjamin Netanyahu vowing to "use whatever force is necessary" to combat militant violence.

The driver, Abdel-Rahman Shaloudi, 21, was shot dead by police as he tried to flee after driving into the crowd at a light railway stop. Seven other people were injured.

Shaloudi's hometown, the East Jerusalem neighbourhood of Silwan, next to the old walled city, has been a scene of confrontations since the incident, which his family has said was a traffic accident.

Police said they dispersed dozens of protesters throwing stones and firebombs in Silwan again on Sunday amid a dispute with relatives over Shaloudi's burial. His family has resisted Israeli demands to limit funeral attendance to fewer than two dozen people.

Tensions have flared in Silwan since a group of Jewish settlers moved in there last month in the largest purchase of homes in the largely Palestinian-inhabited area by Jews since 1986.

Violence through much of East Jerusalem preceded the 50-day Gaza war that ended in August. A Palestinian youth from Jerusalem's Shoafat area was torched to death in June, an attack for which three Jewish men have been charged in an alleged act of revenge for the slaying of three Israeli teens earlier that month.

Israel captured East Jerusalem along with Gaza and the West Bank in the 1967 Six Day War. It annexed the city shortly afterwards as part of its capital in a move never recognised internationally. Palestinians want the city to be capital of a state they seek in occupied territory.

Israel has poured several thousand police reinforcements into the city in the past week to deal with the latest unrest.

Netanyahu told his cabinet on Sunday: "There are extremist Islamist elements trying to ignite the Israeli capital and we shall use whatever force is necessary ... so they shall not succeed."

Illustrating the volatile atmosphere in the city, a news report said authorities had decided to postpone teenagers' traditional coming of age ceremony visits to Jerusalem's Western Wall, which is near Silwan.

Israel's ultra-nationalist housing minister, Uri Ariel, announced he may personally add to the expansion of Silwan's Jewish enclave by moving there.

"We are examining the possibility of moving to rent a place in Ir David," Ariel said on Channel 2 television, using the Hebrew name for Silwan, meaning "City of David".

"I hope very much in the coming days we will make the decision," Ariel said.

Around 90 settler families totalling 500 people live in Silwan among some 50,000 Palestinians.

Jordan warned Israel on Sunday that their peace treaty would be threatened by continued settlement building.

But despite objections to settlement building as a violation of international law, far-right cabinet ministers were pressing Netanyahu to approve building 2,000 more settlement homes and pave a dozen new settler roads, Israeli television said.

Israel's centrist finance minister, Yair Lapid, appeared to confirm the report in a statement that said: "This plan will lead to a serious crisis in Israel-U.S. relations and will harm Israel's standing in the world."

In a related development, a senior defence source confirmed media reports that Palestinians working in Israel would soon be kept off buses destined for major settlements and be forced to return to the West Bank via a specific checkpoint.

The source denied that this was a form of segregation.

"There won't be any ban on them (Palestinians) riding the buses with Israelis," the source said, adding that requiring use of the checkpoint would help avert violence.

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