The Israeli settlement of Har Homa crowns a hill on the south-eastern approach to Jerusalem and towers over the birthplace of Jesus.

It is built on land occupied by Israel in the 1967 war - which makes it a "settlement" in the eyes of the world - and shot up the agenda when Israel announced recently that it planned to build 307 more homes there.

By adding to a "settlement" Israel was accused by the Palestinians and the international community of breaking the spirit of last November's meeting in Annapolis that barred all settlement growth.

Crucially, the United States turned on its ally, flatly rejecting Israel's defence that Har Homa was a suburb of Jerusalem. Condoleezza Rice, the American secretary of state, has criticised Israel publicly.

"Har Homa is a settlement the United States has opposed from the beginning," she said, adding that America makes "no distinction" between Israeli communities built in the West Bank or closer to Jerusalem.

The message was sharp: unless Israel stops plans to build at Har Homa, it could destroy the post-Annapolis peace process.

There was little sign of the gathering diplomatic storm during a visit to the orderly little town.

Jewish children enjoyed some winter sunshine as they played quietly in small parks near the ruins of a Byzantine fort that once crowned this strategic height.

Building continued apace on new apartment blocks.

"As one of the longest residents here I have come to be convinced of our moral right to be here," said Reuven Levy, 39, an estate agent.

This argument does not convince Palestinians, who argue the Arab-owned land was undeveloped forest precisely because Israel had forbidden Arab development since taking control of the area in the 1967 war.