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There are more than 600,000 Israelis living in more than 200 settlements in the West Bank and East Jerusalem. With the expansion of settlements, Palestinians see the chances of finding a two-state solution dimming, as they want these areas for a future state.
The UN Security Council in 2016 demanded a complete stop to the building of settlements and passed a resolution designating them a violation of international law and a major obstacle to peace in the Middle East.
"We regret the decision and the announcement made by the United States," UN spokesman Stephane Dujarric told reporters on Tuesday.
UN Human Rights Office spokesman Rupert Colville reiterated that the UN's position on settlements had not changed.
"A change in the policy position of one state does not modify existing international law, nor its interpretation by the International Court of Justice and the Security Council," he said.
A spokeswoman for Germany's Foreign Office said Berlin would continue to work with its partners in the European Union for a negotiated solution that considers the legitimate demands of both parties.
Arab League chief Ahmed Abul Gheit described the US statement as an "unfortunate change" that can lead Israeli settlers to "practice more violence and brutality against Palestinian population and undermines any tiny prospect to achieve comprehensive peace" through US efforts.
Russia also warned that the change in US policy could worsen tensions in the region. It was joined in condemning the change by Syria, Egypt and Jordan, which all reiterated that the settlements are illegal.
Pompeo said the pro-Israel move provides a chance for a negotiated peace as opposed to a continuation of a dispute over the settlements' legality.
The Israeli government welcomed the move, with Prime Minster Benjamin Netanyahu saying during a visit to a West Bank settlement on Tuesday that the Trump administration "has corrected a historic injustice."
"This is a very great day for the state of Israel and an achievement that will stand for generations," he added.
Saeb Erekat, the Palestinian Liberation Organization's secretary general, said: "Israeli settlements steal Palestinian land, seize and exploit Palestinian natural resources, and divide, displace and restrict the movement of the people of Palestine."
He called on the international community to respond to the US action and criticized the Trump administration's "unceasing attempts to replace international law with the 'law of the jungle.'"
Analyst Jihad Harb, who works with Masarat think tank in Ramallah, said that he doesn't believe there will be a widespread Palestinian reaction to the US decision.
Firstly, Harb said, Palestinians believe these decisions will eventually be annulled. Secondly, Palestinians feel a sense of frustration as a result of the local and international political situation, and they are not encouraged to react or take to the streets as a result.
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