The rift in US-Israel relations deepened today after American envoy George Mitchell cancelled a visit and Jerusalem insisted it would not back down over building plans at the heart of the row.
Meanwhile hundreds of Palestinians hurled stones at police and started fires across the holy city's volatile eastern sector, where the construction is planned.
Plumes of black smoke billowed and the air reeked of tear gas in the heaviest clashes in the city in months.
Youths in one east Jerusalem neighbourhood hoisted a giant Palestinian flag and shouted: "We'll die in Palestine, Palestine will live."
Thousands of police, including anti-riot units armed with assault rifles, stun grenades and batons, were deployed across east Jerusalem to stifle the unrest. No serious injuries were reported.
The diplomatic crisis erupted last week after Israel announced during a visit by US vice president Joe Biden that it would build 1,600 apartments for Jews in disputed east Jerusalem, the sector of the holy city that the Palestinians claim for a future capital.
The announcement enraged Palestinians, who have threatened to bow out of US-brokered peace talks that were supposed to begin in the coming days. The Obama administration, fuming over what it called the "insulting" Israeli conduct, has demanded that Israel call off the project.
Foreign Minister Avigdor Lieberman said demands to halt Israeli construction there "are unreasonable" and predicted the row with the US would blow over, saying neither side had an interest in escalation.
But Washington told Israel today that envoy George Mitchell had put off his trip indefinitely. Mr Mitchell had planned on wrapping up preparations for relaunching Israeli-Palestinian peace talks. However, now it is not clear when the indirect talks will begin.
Israeli Prime Minister Benjamin Netanyahu has apologised for the timing of the project's approval, but he has not said it would be cancelled.
The feud is feeding already high tensions in east Jerusalem, where Jews and Palestinians live together uneasily.
The violence also threatened to spread to the West Bank. At the main checkpoint between the West Bank and Jerusalem, dozens of Palestinian youths threw stones and a few firebombs at Israeli troops, who responded with tear gas and rubber bullets.
In east Jerusalem, security forces, some on horseback, charged a group of more than 100, who had started fires and lobbed rocks at police.
Palestinian officials called on the public to defend Muslim religious interests in Jerusalem following the rededication yesterday of a historic synagogue in the Jewish quarter of the Old City.
The rededication has stoked recurring but unsubstantiated rumours that Jewish extremists are planning to take over the hilltop shrine at the crux of the Israeli-Palestinian conflict.
The site, known to Jews as Temple Mount, was home to the Biblical Jewish temples and is Judaism's holiest site.
Muslims call it the Noble Sanctuary and it hosts the Al-Aqsa mosque complex, Islam's third-holiest shrine.