A Palestinian toddler was burned to death and four family members wounded in an arson attack by suspected Jewish settlers on two homes in the occupied West Bank on Friday.

Israeli Prime Minister Benjamin Netanyahu called the firebombing in the village of Duma near the northern city of Nablus "an act of terrorism in every respect" and ordered security forces to hunt down the perpetrators.

The attack further stoked tensions between Israelis and Palestinians, two days after Netanyahu controversially approved 300 new settler homes in the West Bank.

The Palestine Liberation Organisation said it held Netanyahu's government "fully responsible" for the death of 18-month-old Ali Saad Dawabsha, arguing it was "a direct consequence of decades of impunity given by the Israeli government to settler terrorism."

Palestinian president Mahmud Abbas called for an investigation by the International Criminal Court in The Hague.

According to Palestinian security officials, four assailants believed to be Jewish settlers set a house on fire at the entrance to the village and scrawled graffiti on a wall before fleeing to a nearby Jewish settlement.

The Israeli military and army radio said two homes had been set ablaze by two masked men, and a child killed and four family members wounded. It added that the graffiti had been written in Hebrew.

Palestinian sources said those wounded included the toddler's parents -- mother Reham, 26, and father Saad -- as well as four-year-old brother Ahmed. Israeli medical sources said they had been taken to hospital.

The mother was in critical condition with third-degree burns covering 90 percent of her body, an Israeli doctor told public radio, stressing that her life was threatened. The father had burns on 80 percent of his body.

The identity of the fourth person wounded as reported by the military was not immediately clear.

Local media reported that the graffiti said "revenge" and "long live the Messiah" and that the attackers threw firebombs inside the two homes, one of which was empty.

Israeli Defence Minister Moshe Yaalon said such attacks would not be tolerated, adding "we will not allow terrorists to take the lives of Palestinians."

The Israeli military said it was working to find the perpetrators.

- Tensions over settlements -

Protests were expected after the main weekly Muslim prayers across the Palestinian territories, with Islamist movement Hamas having already on Thursday called for a "day of rage" against what it called Israeli aggression.

Israeli authorities mobilised a large deployment in Jerusalem's Old City around the flashpoint Al-Aqsa mosque and barred men under 50 years old from entering the complex. Previous such moves have provoked anger from Palestinians.

The arson attack follows days of tensions surrounding settlements in the West Bank, with rightwing groups opposing the demolition of two buildings under construction that the Israeli High Court said were illegal.

The demolition began on Wednesday, but Netanyahu authorised the immediate construction of 300 settler homes in the same area the same day.

Settlers had clashed with police when they moved in to demolish the buildings. Education Minister Naftali Bennett, of the right-wing Jewish Home party, had opposed the demolition and addressed protesters at the site.

Netanyahu holds only a one-seat majority in parliament following March elections and settler groups wield significant influence in his government.

West Bank settlements are viewed as illegal under international law, but not by the Israeli government.

They are also major impediments to peace negotiations with the Palestinians, who see the land as part of a future independent state, and Western nations have called on Israel to halt construction.

Neighbouring Jordan, one of the rare Arab nations with diplomatic relations with Israel, strongly condemned the arson attack.

"This ugly crime could have been avoided if the Israeli government had not ignored the rights of the Palestinian people and turned its back on peace... in the region," government spokesman Mohammed Momani said.

Extreme-right Israeli activists have committed acts of vandalism and violence against Palestinians and Arab Israelis for years, attacking Christian and Muslim places of worship and even Israeli soldiers.

The attacks are known as "price tag" violence -- a euphemism for nationalist-motivated hate crimes by Jewish extremists.