Tensions between the United States and Israel over settlement expansion in the West Bank escalated this weekend over a tinderbox issue: Israeli building in East Jerusalem, a predominantly Arab area that Israel claims as part of its "undivided and eternal capital."

"I can only imagine what would happen if someone were to suggest that Jews cannot live in certain neighborhoods in New York or in London or in Paris or in Rome," Israeli Prime Minister Benjamin Netanyahu said on Sunday, responding to newly clarified US demands to freeze all new building. "There would undoubtedly be a loud international outcry. All the more so, we cannot agree to such a decree in Jerusalem."

At issue is Washington's request to suspend plans to convert an old hotel into 20 Jewish apartments in Sheikh Jarrah – an Arab neighborhood of East Jerusalem and one that Palestinians see as part and parcel of their future capital. The Shepherd's Hotel, an empty 1930s-era building, is owned by US bingo magnate Irving Moskowitz, who has purchased other properties in East Jerusalem and the West Bank to settle Jews in areas right-wingers don't want handed over to Palestinian control.

"Netanyahu is keen to lay down some red lines in terms of what, in his point of view, is discussable and what is not," says Jonathan Spryer, a Middle East analyst at the Inter-Disciplinary Center in Herzliya, Israel. "He's saying, we can argue on numbers in the West Bank, but as far as Jerusalem goes, your interference is off-limits."

Since expanding its border in the 1967 war with its Arab neighbors, Israel has steadily built new Jewish "neighborhoods" across the Green Line, Israel's pre-1967 perimeter. By the international community's yardstick, that makes them settlements.

East Jerusalem, which Israel annexed in the same war, is ruled by Israeli law – making it legitimate, Israeli officials argue, for anyone to buy and develop real estate there.

Israeli media question Netanyahu's motives

For those striving for a two-state solution to the Israeli-Palestinian conflict, putting a new Jewish housing complex in Sheikh Jarrah could present another obstacle to designating certain areas for an eventual Palestinian capital. At the very least, many say it calls into question the sincerity of Mr. Netanyahu, who announced his support for the two-state solution last month.

Much of the Israeli media on Monday was focused on Netanyahu's latest wrangle with Washington, the leading columnist of Yediot Aharonot calling it a "hypocritical, sanctimonious statement" to compare the situation in Jerusalem to that in other cities. The Haaretz newspaper said that Netanyahu's support of the project "casts doubt over [his] willingness to enter serious negotiations on a final status agreement."

But Maariv, one of Israel's mass-circulation papers, reported the latest flap as evidence that Netanyahu was flexing his muscles and demonstrating he would not take "dictates" from Washington.

Netanyahu caught between international demands, domestic pressure

All of which, analysts say, suggest Netanyahu is trying to have it both ways: to limit settlement growth enough to meet international demands for a freeze, but allow the construction of some controversial projects – particularly those in Jerusalem, since they are considered part of the Israeli public "consensus" – so as to keep up his popularity level with his domestic audience.

"Netanyahu wants to say that, 'When it comes to Jerusalem, I have a majority of Israelis behind me, and if you make an issue out of it, we're in for a public argument, front and center,' " says Dr. Spryer.