"I have determined that it is time to officially recognise Jerusalem as the capital of Israel," Trump said in a televised speech on Wednesday.
The president said he ordered the State Department to develop plan to relocate the American embassy from Tel Aviv to Jerusalem.
He added he is not taking position on any final status issues, including contested borders. Trump said he intends "to do everything" in his power to help forge a peace deal between Israelis and Palestinians.
Shortly after Trump's speech, Saeb Erekat, the chief Palestinian negotiator, said the US president "destroyed any possibility of peace" and was "pushing this region towards chaos [and] violence".
"He's destroying all moderates in the region and he's giving power to extremists," Erekat told Al Jazeera from Jericho.
"This is the most dangerous decision that any US president has ever taken," he said, adding that Trump had "disqualified his country from any possible role in the peace process".
"How can he talk about peace when he dictates the future of Jerusalem before negotiations begin, in total violation of international law?" asked Erekat, saying it is "meaningless" to have a Palestinian state without Jerusalem as its capital.
The only option remaining for Palestinians, he said, "is to fight for equal rights" between the Mediterranean Sea and the Jordan River, the area of historic Palestine.
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