A sensitive issue facing the government of Prime Minister Menachem Begin was defused today when residents of the illegal Jewish civilian settlement at Elon Moreh, in the occupied West Bank, decided to abandon their outpost rather than force a confrontation with the Israeli Army.

With work nearly complete on an alternative site nearby at Jebil Kabir, near Nablus, the Elon Moreh settlers voted among themselves to move from privately owned Arab property that was confiscated by the government last June. On Oct. 22, Israel's High Court of Justice, in an unprecedented decision, said the seizure of the Arab land violated international law, including the Geneva and Hague conventions governing the conduct of occupying armies.

The ultranationalist settlement movement Gush Emunim (faith block), had vowed to resist forcibly government attempts to move them to the new site, which was prepared at a cost of about $1 million. Top officials of the Begin government had predicted that if military force was ever used to evict Elon Moreh residents, the fragile coalition government could not have survived.

Mikhail Shuuvt, an Elon Moreh leader, said today, "A lot of pain and sorrow was involved in our decision to move to Jebil Kabir. But we realize that the time has come to have a Jewish city near Nablus."

Nablus is the largest -- and most militantly nationalistic -- Arab city in the West Bank.

Despite seasonal rains and cold weather, the government already has erected 14 portable homes at Jebil Kabir, and plans to build a total of 40 homes,

In another development, Israeli Interior Minister Yosef Burg, head of Israel's negotiating committee on autonomy for Palestinian Arabs in the West Bank and Gaza Strip charged today that Egypt has seriously undermined the peace process by rejecting Israel's first bargaining position. The Israeli plan, which observers had predicted would be rejected, would give Palestinian control of only about a dozens basic municipal services, while keeping in Israeli hands ultimate political authority.

Izzat Abdul-Latif, head of the Egyptian delegation, said the Israeli proposals "are not in line with the Camp David agreements calling for full autonomy involving all powers in the legislative and executive fields." Egypt has proposed setting up a legislative body for Palestinian Arabs in the occupied areas.

Burg today said, "The total rejection by Egypt brings us back at least six months . . . and perhaps more."

Burg noted, however, that Israeli and Egyptian negotiating teams, joined by special U.S. envoy Sol Linowitz, will resume deliberations in Tel Aviv at the end of the month and that there is still room for progress.

In another development, officials here have confirmed that a Palestinian-born American citizen suspected by Israeli authorities of having made contact with the Palestine Liberation Organization in Lebanon has been imprisoned here for 3 1/2 weeks.

Isa Suleyman Hanna, 35, was arrested on Dec. 24 in Ramallah, on the West Bank, where he went to visit his family, authorities said. He had arrived at Ben Gurion Airport the previous day and was told to report to the military government headquarters in Ramallah, where he was arrested.

Under Israeli security law, a foreign national visiting Israel can be arrested if he is known to have had contact with the PLO, even if the contact is made outside Israel's jurisdiction.

Hanna, who was born in Palestine and naturalized in the United States in 1975, is being held without charges under an emergency security decree dating back to British mandate in Palestine. Four days after his arrest, his detention was extended 18 days, after which a military court issued a further 30-day extension, officials said. a

U.S. consular officials said they have maintained "regular" contact with Hanna since his arrest, although a spokesman for the military government said the suspect would not be permitted to see a lawyer or his family until the investigation is completed.

Israeli officials denied charges made by the Palestine Human Rights Committee in a press conference in Chicago last week that Hanna has been blindfolded and bound during his confinement. Hanna reportedlly had been living in Chicago.

"He has made no complaint about mistreatment. The only problem is that he says he is a little bit cold," the military government spokesman said this week.

A Foreign Ministry official said that Hanna, prior to his arrival in Israel, had made contact with an "illegal organization" in Lebanon and that "he knew what he was suspected of when he was brought before the military judge."

In a similar case Sami Esmail, a Brooklin-born American of Palestinian descent, was convicted in June 1978 on charges of joining the Popular Front for the Liberation of Palestine while he was a student in Michigan. Terre Fleener, another American, served 20 months of a five-year sentence in an Israeli jail after allegedly contacting the PLO in Lebanon and Cyprus and taking photographs here for use by terrorists.