Something is moving in the Middle East but it has not yet arrived in Jerusalem. A new chess game has started in the region: the US ambassador is returning to Damascus, the Hamas leader, Khaled Meshaal, made a speech welcoming the new tone set by Barack Obama in his speech in Cairo, there are leaks of an imminent deal between the Israelis, Egyptians and Hamas over a prisoner exchange and pressure is being brought to bear on Fatah and Hamas to reconcile so that credible negotiations for a Palestinian state can begin.

These opening moves have prompted a tentative dusting-down of the various proposals for a peace agreement and a resurrection of some of the informal Palestinian-Israeli dialogues. No one quite dares to hope that a credible peace process may soon be under way, having become so used to US presidents blinking first in any standoff with the Israeli government. Nevertheless, expectation of a concerted and credible policy initiative from the US have never been higher among advisers and commentators. A lobbyist who recently returned from Washington remarked "there's a complete change in focus – and more importantly there is not a chink of light between Obama, [Hillary] Clinton, [George] Mitchell and the other US agencies involved with the Middle East".

Yet these hopeful signs are not reflected on the ground in the city of Jerusalem. Rather, some talk of a growing crisis. "An explosion may be imminent," a municipal council member told me. It is easy to see what he meant. The rupture to employment, family life, community cohesion and access to services and cultural amenities caused by the huge separation wall running through the eastern edge of Jerusalem has been enormous. Demolitions of Palestinian houses in East Jerusalem, which continue to sow bitterness and anger; the increased cancelling of East Jerusalem ID cards, which deprives people of residency in the city, access to services and National Insurance benefits; the systematic erosion of Palestinian territory through zoning plans; and the land acquisitions of the Israeli settlers all combine to produce a highly volatile situation.

Adding to this sense of deterioration on the ground is the leadership vacuum in the Palestinian community in East Jerusalem. The Israelis have successfully pursued a policy of excluding the Palestinian Authority, of restricting the cultural and service delivery activities run by Palestinians, and of decapitating the Hamas movement through incarceration. Furthermore, the traditional elite associated with the Haram al-Sharif is paralysed through the tight monitoring of employees by its Jordanian paymasters. The result is a fragmented and incoherent response to the inroads being made into the Palestinian parts of the city by Israel.

Into this vacuum has entered the charismatic Sheikh Raed Salah, one of the leaders of the Palestinians in Israel. Rallying the resistance to house demolitions and to the perceived defilement of Islamic cultural monuments, Salah has demonstrated his ability to mobilise the Palestinian street. His campaign to defend the Haram al-Sharif from settler encroachments with the slogan "al-Aqsa is in danger" and the organised bussing in of protesters every day of the week has resonated internationally. To the consternation of the Palestinian Authority and the East Jerusalem elite he has been nicknamed "the sheikh of al-Aqsa" and "the mayor of Jerusalem". Whether this presence can be successfully transmuted into impact on Israeli policy is yet to be seen, but there is no doubt that foundations of a platform are being laid.

So why is there this dissonance between the mood in the region and the grim polarities in Jerusalem? One reason is time-lag. The positive knock-on effects of Obama's Cairo speech have not had time to percolate down to the street. Nevertheless, a number of patterns are emerging. One way of interpreting Israeli actions in the city is to see them as moves immediately prior to a ceasefire. Favourable positions are being sought quickly in case they become the new status quo. Another possibility is that Israel has taken a strategic decision to consolidate its hold over Jewish areas in the east of the city – the settlements and the central areas of what has been called the Holy Basin, which contains the Old City and most of the holy sites. The focusing of investment into these areas and the neglect of others can easily be seen by a visit to the eastern periphery. Technically inside the municipal boundaries of the city, areas such as Kufr Aqab and Shu'afat refugee camp have been placed on the West Bank side of the separation wall and have all but been abandoned by the municipality. Apart from a few cosmetic services, they have been abandoned to high unemployment, congested housing and physical isolation from the city.

On the Palestinian side, there seems to be a "wait and see" approach. There is little desire to expend resources or political capital on new initiatives until it is clear that Obama will not back down over the settlement freeze issue. Having prematurely revealed that they are prepared to accept Israeli sovereignty over the Western Wall and Jewish quarter in the Old City (borders yet to be decided), the Palestinians are unwilling to engage in anything less than final status discussions. They are through with interim phases. Alongside this greater clarity one can also feel a hardening of their position on the city. While an Israeli recognition of Palestinian sovereignty east of the 1949 armistice line will open the doors to the consideration of special arrangements for the holy sites and the Old City, it is also clear that the Palestinians will refuse to go down in history as those Muslims and those Arabs who sold out on Jerusalem. On Jerusalem, the conclusion is: no deal is better than a bad deal.