The Israeli government yesterday rejected Egyptian President Anwar Sadat's latest suggestion for a peace settlement, calling Sadat's proposal that the West Bank and the Gaza Strip be turned over to Jordan and Egypt an "unacceptable" prior condition to reopening negotiations.

The Cabinet, after a closed meeting, issued what it called an "unreserved" rejection of Sadat's latest offer without waiting to receive it formally through diplomatic channels. The ministers based their decision on a transcript of Sadat's statement as broadcast by Cairo radio.

Sadat, meanwhile, was reported by Egyptian officials to be continuing to work on the Egyptian proposal in Alexandria yesterday. The plan is expected to be given to the United States within a few days.

The thrust of the Sadat plan, which has been presented before in slightly different form, is that as an interim solution. Israel relinquish the West Bank to Jordan and the Gaza Strip to Egypt, and that negotiations then be held on matters of border security.

Sadat advanced a similar idea last month as an alternative to negotiating with Israel for the establishment of a Palestinian state in the territories seized by Israel in the 1967 six-day war.

The new proposal reportedly will be the foundation of the peace plan that Egyptian Foreign Minister Mohammed Ibrahaim Kamel will present if a tentatively scheduled meeting with Israeli Foreign Minister Moshe Dayan and Secretary of State Cyrus Vance takes place next month in London.

"As broadcast from Cairo, Sadat's statements constitute a prior condition," said Cabinet Secretary Aryeh Naor.

Naor dismissed the suggestion that Sadat's statement was a peace proposal, which Israel has persistently invited Sadat to submit.

"If what Egypt wants to present constitutes a prior condition, then it is unacceptable," Naor said. "We insist that there be negotiations without prior conditions."

The cabinet also reportedly discussed, but did not act on, the controversy surrounding Defense Minister Ezer Weizman and remarks he reportedly made about Dayan and Prime Minster Menachem Begin while the Cabinet was debating the future of the West Bank and Gaza.

Although his office issued a statement denying it, Weizman was reported to have declared in a corridor outside the prime minister's office. "Those two men (Begin and Dayan) have been lying to us for months. They are leading the nation to war."

Weizmen, who unsuccessfully attempted to win Cabinet approval of his own formula for the long-range future of the West Bank and Gaza, met with Begin before yesterday's Cabinet meeting shortly atter Commerce Minister Yigal Hurvitz reportedly began arguing for the defense minister's removal.

Weizman's critics contend that Begin's draft answers to questions posed by the United States about the occupied territories after a five-year limited self-rule plan at least carried a facade of being diplomatically candid. But they argue that by attacking the answer, Weizman subjected Begin and the government of unnecssary outside criticism.

Supporters of Weizman say that Begin answers were so vague that they would have invited criticism without any commentary from Weizman.

Sources close to the prime minister say that while Begin might welcome a rebuke of Weizman at either of today's political meetings, he does not want Weizman to resign from the Cabinet at this time. For his part, Weizman is said to have decided to quietly resume his ministerial duties and, for the time being, keep a safe distance from foreign policy matters.

Weizman is known to have told friends that he is disillusioned with politics as a result of the Cabinet dispute last week, and that the enmity between him and Dayan has deepened over the issue.

But Begin appeared to be caught in a dilemma of his own: If he fires Weizman he will lose one of his strongest Cabinet ministers, but if he does nothing he will lose some of his stature as a strong leader.