Calling Israel's sovereignty over Jerusalem indisputable, Prime Minister Benjamin Netanyahu on Sunday rejected U.S. demands to stop plans to build 20 Jewish-owned apartments in the eastern part of the city that Palestinians regard as key to their future state.

The decision to allow new housing on land annexed by Israel after the 1967 war probably will further agitate relations with the Obama administration, which has been pressuring Netanyahu to halt the expansion of settlements in hopes of reviving the Middle East peace process and enticing Arab nations to normalize relations with the Jewish state.

The sensitivity concerning the project, proposed by a Jewish American millionaire, was highlighted over the weekend when Israeli officials said the country's ambassador to Washington, Michael B. Oren, was summoned to the State Department. But Netanyahu, referring to news reports about the U.S. opposition to the plan, was unwavering, saying that a united Jerusalem was the capital of Israel and that there would be no limits on Jewish construction.

While refusing to rule out natural growth in existing settlements, Israel has pledged not to build new settlements and not to confiscate more land. Israel doesn't consider projects in East Jerusalem to be settlements, but rather legitimate expansions in a section of the city it captured in the Six-Day War.

"We cannot accept the idea that Jews will not have the right to live and purchase [homes] anywhere in Jerusalem," Netanyahu told reporters at the start of his weekly Cabinet meeting. "I can only imagine what would happen if someone would propose that Jews could not live in certain neighborhoods of New York, London, Paris or Rome. There would certainly be a major international outcry. We cannot accept such a decree in Jerusalem."

Chief Palestinian negotiator Saeb Erekat said that Netanyahu's comments were a distraction from the peace process and that East Jerusalem, like the West Bank, would one day be freed from occupation to become part of a Palestinian state. Washington and the international community hold that Jewish expansion in disputed East Jerusalem is a major deterrent in solving the Israeli-Palestinian crisis.

"The job of the prime minister of Israel is to prepare his people for peace," Erekat said. "Settlements and peace are two parallels that do not go together. It is either settlements or peace."

For the last two months, Israeli Defense Minister Ehud Barak and special U.S. envoy George J. Mitchell have met several times to try to resolve what has turned into the most publicly pointed disagreement in years between Israel and Washington.

The Israeli activist group Peace Now said construction in East Jerusalem -- home to holy sites for Christians, Jews and Muslims -- is not supported by all Israelis and "undermines the chances of the city becoming the joint capital of Israel and the future Palestinian state."

Conservative voices, however, fear that forgoing construction in East Jerusalem will only invite more outside pressure on Israel to curtail its development within the city. Ophir Akunis, a Likud Party member of the Knesset, Israel's parliament, said: "All countries in the world must understand that on the issue of Jerusalem, we will not receive dictates."

The project in East Jerusalem is funded by U.S. businessman Irving Moskowitz, who has backed a number of housing projects in the city. It calls for building 20 apartments on land that includes the old Shepherd's Hotel, which was constructed in the 1930s for the grand mufti of Jerusalem, Haj Amin Husseini. After the Six-Day War, the hotel became a courthouse under the Israeli Ministry of Justice. It has been empty for about 15 years. The Jerusalem Planning Committee, which approved Moskowitz's project, said copies of the proposal were given to the U.S. and British consulates.

Jerusalem Mayor Nir Barkat said in statement: "According to the High Court of Israel, Jews, Muslims and Christians alike can purchase land in all parts of the city of Jerusalem."