By AMY TEIBEL

JERUSALEM (AP) - Israel on Sunday rejected a U.S. demand to suspend a planned housing project in east Jerusalem, threatening to further complicate an unusually tense standoff with its strongest ally over settlement construction.

Israeli officials said the country's ambassador to Washington, Michael Oren, was summoned to the State Department over the weekend and told that a project being developed by an American millionaire in the disputed section of the holy city should not go ahead.

Settlements built on captured lands claimed by the Palestinians have emerged as a major sticking point in relations between Israel and the Obama administration because of their potential to disrupt Mideast peacemaking.

Although Prime Minister Benjamin Netanyahu recently yielded to heavy U.S. pressure to endorse the establishment of a Palestinian state, he has resisted American demands for an immediate freeze on settlement expansion.