His remarks, in a parliamentary speech, went a little further than Israel's longtime policy of viewing Jerusalem, a city at the heart of Middle East conflict, as its "indivisible capital".
Addressing a debate marking 45 years since Israel captured and annexed the city's eastern sector, in a move never recognized internationally, Netanyahu said:
"Whoever proposes we take the heart of Jerusalem, the Temple Mount, and take it out of our hands, and that this would bring about peace, I say not only is this a mistake but a fatal mistake."
Netanyahu said that sites holy to Judaism, Islam and Christianity enjoyed a "wonder of inter-religious peace that is maintained thanks to Jerusalem's unity under Israeli sovereignty."
"The Temple Mount is in our hands and ... it shall remain in our hands," Netanyahu added.
The Temple Mount, a site in Jerusalem's old walled city, is revered by Jews as the place where two biblical temples once stood. The area also houses two of Islam's holiest shrines, the al-Aqsa Mosque and the Dome of the Rock.
Israel denies millions of Palestinians access to the city's Muslim and Christian holy sites.
Palestinians want east Jerusalem as capital of a future state in the Gaza Strip and the West Bank, territory Israel also captured in a 1967 war.
Western-sponsored negotiations hit deadlock months ago in a dispute over Jewish settlement building in the occupied West Bank and Jerusalem.
In a related development, Israel's parliament passed a law on Monday granting tax incentives to organizations seen as encouraging settlement in Israel and occupied territory, in addition to tax breaks already offered to settlers in the past.
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