Trump promised throughout the 2016 campaign that he would move the U.S. embassy to Jerusalem, an action the Israeli government has long advocated.
US officials say the process of moving the embassy would take at least six months and involve major adjustments in security, office and housing space and staffing at both the existing facility in Tel Aviv and the consulate general in Jerusalem.
The Palestinians want East Jerusalem as the capital of their future state.
The relocation of the U.S.' Israel embassy to Jerusalem would be seen as a de facto recognition of Israel's claims to the contested city.
The Palestinian Authority's ambassador to the U.S., Husam Zomlot, said that Trump's decision "gives peace a chance" and that the Palestinians "are ready to start the consultation process with the U.S. Administration" on a peace deal.
According to several people familiar with the administration's internal debates - both in Israel and America, all of whom asked to remain anonymous - the group urging Trump to refuse to sign the waiver and finally move the embassy is headed by Bannon himself. Lawmakers later passed the Jerusalem Embassy Act in 1995, signed into law by President Clinton, which authorized the U.S.to move the embassy to Jerusalem by 1999 with one caveat - the president could indefinitely delay the move by signing a waiver, citing national security concerns. The last waiver was signed by former President Barack Obama six months ago.
Jerusalem's status is one of the most emotionally charged matters separating the Israelis and Palestinians.
When Israel was established a year later, the USA and other countries based their embassies in the Tel Aviv area instead of Jerusalem, out of respect for the United Nations plan.
Signing the waiver this week would forestall any move for another six months. "For him, it is a matter of when not if the United States embassy is moved to Jerusalem".
There was high speculation earlier this month, after Trump announced his trip to Israel, that he would use the visit - which came just before Jerusalem Day, when Israel commemorated 50 years since the Six Day War - to announce the move, something he had repeatedly pledged to do as a candidate.
Moving the embassy is "something the President supports, something he supported during the campaign, something he still supports", the official said. He was in the process of negotiating peace with the Palestinians, who also had political claims to Jerusalem.