The contract extension will ensure the 29-year-old remains with the Australian Rugby Union and New South Wales until the end of 2013.
Injuries have restricted Palu to just two of his 38 Test caps in the past two seasons - the cruellest of which was a hamstring strain early in last year's World Cup in New Zealand which ruled him out of the rest of the tournament.
But he is hopeful that the worst of his bad luck is now behind him.
"The last couple of years haven't been easy," Palu said.
"I haven't played nearly as much rugby as I would have liked, but I've had a good run of games so far this year. Hopefully that trend continues.
"The body feels good. The hamstrings have not caused any problems. I've taken a few hits this year and not done any damage, which has definitely added a bit of confidence.
"With every game, I've felt that little bit more comfortable that I am starting to get back - match-fitness wise - to where I want to be."
Palu revealed that being part of next year's British & Irish Lions tour served as added motivation to remain with the ARU.
"It's a once-in-a-career experience if you are lucky enough to play the Lions," he said.
"I didn't want to be sitting there watching the tour go on from a distance, regretting having given up the opportunity to be a part of it."
Waratahs coach Michael Foley welcomed the news of Palu's re-signing.
"We are so excited to have him staying on," Foley said. "The difference he's made at times in unquestionable.
"It's a great endorsement for the guys that he plays with. They are a good bunch of blokes and he wants to keep playing with them.
"He's a rare forward who has a little bit of X-factor.
"Cliff can certainly do things in a game that others can't. He's able to open a game up with an involvement and he gives everyone else a lift when he's on the field."
Palu has played 81 matches for the Waratahs since making his debut in 2005.