Israel should stop building settlements, denying Palestinian development and designating land for exclusive Israeli use that Palestinians seek for a future state, the Middle East peace Quartet recommended in a draft of an eagerly awaited report seen by Reuters.

The draft report by the Quartet countries sponsoring the stalled Middle East peace process – the United States, Russia, the European Union and the United Nations – said the Israeli policy "is steadily eroding the viability of the two state solution". 

"This raises legitimate questions about Israel's long term intentions which are compounded by the statements of some Israeli ministers that there should never be a Palestinian state," according to the draft report.

The day before Israeli elections in March 2015, Israeli Prime Minister Benjamin Netanyahu said there would never be a Palestinian state on his watch, only to backtrack days later and recommit to the objective of a two-state solution.

UN Middle East envoy Nickolay Mladenov briefed the UN Security Council on Thursday on the Quartet report, which he told reporters had been submitted to the Quartet members for final approval and was likely to be released on Friday.

Diplomatic sources said the report carries significant political weight as it has the backing of close Israeli ally the United States, which has struggled to revive Middle East peace talks amid a fraught relationship between Netanyahu and US President Barack Obama.

The relationship between the right-wing Israeli leader and the Democratic US president has yet to recover from deep differences over last year's US-led international nuclear deal with Israel's foe Iran.

The draft report said Israel had taken for its exclusive use some 70 per cent of Area C, which makes up 60 per cent of the occupied West Bank and includes the majority of agricultural lands, natural resources and land reserves.

"The transfer of greater powers and responsibilities to Palestinian civil authority in Area C, contemplated by commitments in prior agreements, has effectively been stopped and in some ways reversed and should be resumed to advance the two state solution and prevent a one state reality from taking hold," the draft Quartet report said.

The draft report said that at least 570,000 Israelis are living in settlements. The United Nations and most countries consider the settlements illegal.

"Israel should cease the policy of settlement construction and expansion, designating land for exclusive Israeli use and denying Palestinian development," the draft Quartet report recommends.

It said that only one permit for Palestinian housing construction in Area C was reportedly approved in 2014, while there did not appear to have been any approved in 2015.

The Palestinians want an independent state in the West Bank, Gaza and East Jerusalem, areas Israel captured in a 1967 war. The last round of peace talks broke down in April 2014, and Israeli-Palestinian violence has surged in recent months.

A Palestinian fatally stabbed a 13-year-old Israeli girl, who had US citizenship, in her bedroom in a settlement in the West Bank on Thursday.

"The Palestinian authority should act decisively and take all steps within its capacity to cease incitement to violence and strengthen ongoing efforts to combat terrorism, including by clearly condemning all acts of terrorism," the draft Quartet report said.

Mladenov told the Security Council on Thursday the Quartet report outlines a "reasonable set of steps" that could be taken to put Israel and the Palestinians on the path to peace.

He said the report concluded that continuing violence, terrorism and incitement; Israeli settlement expansion and a lack of control of Gaza by the Palestinian Authority "severely undermine hope for peace".

The Palestinian Authority headed by President Mahmoud Abbas is based in the West Bank, while Islamist group Hamas has been in control of Gaza since 2007.