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"Australia now recognises West Jerusalem, being the seat of the Knesset and many of the institutions of government, is the capital of Israel," Morrison said.
"We look forward to moving our embassy to West Jerusalem when practical," he told reporters in Sydney.
Morrison said in October he was open to shifting Australia's embassy from Tel Aviv. President Donald Trump's decision to move the U.S. embassy to Jerusalem from Tel Aviv in May delighted Israel, infuriated Palestinians and upset the wider Arab world and Western allies.
Morrison's unexpected announcement in October was viewed cynically because it came days before a crucial by-election in an electorate with a strong Jewish representation, a poll his party subsequently lost.
It also drew criticism from Muslim-majority neighbours such as Indonesia and Malaysia, neither of whom formally recognise Israel's right to exist. Arab countries worried that the move would unnecessarily inflame tensions in the Middle East.
Israel regards all of Jerusalem as its capital, including the eastern sector that it annexed after the 1967 Middle East war, and wants all embassies based there. The international community believes Jerusalem's status should be resolved through negotiation.
The status of Jerusalem, home to sites holy to the Muslim, Jewish and Christian faiths, is one of the biggest obstacles to a peace agreement between Israel and Palestinians who want East Jerusalem recognised as the capital of a Palestinian state.
Morrison said Australia would not move its embassy to West Jerusalem until the city's final status was determined, but said trade and defence offices would be opened there.
He confirmed Australia's support for a two-state solution with a Palestinian capital in East Jerusalem.
"What we are saying is we've got to move this forward. The rancid stalemate has to be broken," he said.
- Reporting by Tom Westbrook. Additional reporting by Alison Bevege. Editing by Paul Tait