Israel is coming under increasing US pressure to scrap the east Jerusalem building project which has sparked the most serious diplomatic feud in years.
US officials have lined up in recent days to condemn the Israeli plan to build 1,600 apartments in the sector of the city that the Palestinians claim for their future capital.
The project was announced during US vice President Joe Biden's visit to the region last week, badly embarrassing the US and complicating its efforts to restart Israeli-Palestinian peacemaking.
Israeli officials said Washington wants the project to be cancelled.
Although Israeli prime minister Benjamin Netanyahu has apologised for the timing of the project's approval, he has not said he will cancel it.
Israel does not stand to benefit from antagonising its most important ally but Mr Netanyahu has historically taken a hard line against territorial concessions to the Palestinians and a curb on east Jerusalem construction would threaten to fracture his hawkish coalition.
The Israeli officials said the US also wants Israel to make a significant confidence-building gesture toward the Palestinians including possibly releasing hundreds of Palestinian prisoners or turning over additional areas of the West Bank to Palestinian control.
Washington, they said, also has demanded that Israel officially declare that talks with the Palestinians will deal with all the conflict's big issues including final borders, the status of Jerusalem and the fate of Palestinian refugees who lost their homes during the war around Israel's 1948 creation.
The unusually harsh US criticism has undercut Mr Netanyahu's efforts to suggest that the crisis had passed.
East Jerusalem has been perhaps the most intractable issue dividing Israelis and Palestinians. Israel annexed the territory after capturing it in the 1967 Middle East war but the Palestinians and the international community have not recognised that move.
The renewed settlement dispute has further fuelled frictions in the city.
For a fourth day, Israel deployed hundreds of police around east Jerusalem's Old City, home to important Jewish, Muslim and Christian shrines, and restricted Palestinian access to the area in anticipation of possible unrest.