The United States has issued a stark warning to Israel’s US ambassador over planned settlement construction in East Jerusalem and demanded that the project be scrapped.

But Prime Minister Benjamin Netanyahu has said that "Israel will not agree to edicts of this kind in East Jerusalem."

Israeli ambassador to the US Michael Oren was summoned to a meeting at the state department where he was told the US sought a freeze on new settlement construction in the east of the capital where an old hotel is being turned into Jewish homes by an American developer.

Irving Moskovitz, the developer, received planning permission from the Israeli government to build 20 apartments for Jews in the Shepherd Hotel, in East Jerusalem's Sheikh Jarrah neighborhood.

During Barak Obama’s recent meeting with Netanyahu, the US president made it clear he saw new settlement building as the major obstacle to peace, and would seek a complete freeze on settlement construction.