A Palestinian worker walks through the construction site in the East Jerusalem neighbourhood of Ramat Sholmo last Thursday. (Dan Balilty/Associated Press)

Israeli Prime Minister Benjamin Netanyahu says his country's controversial plan to build homes in east Jerusalem won't harm Palestinians.

Netanyahu told the Israeli parliament Monday that the 1,600 homes will "in no way" hurt Palestinians.

But the building has certainly hurt relations between Israel and the United States, which are facing their worst crisis in 35 years, according to published reports.

Michael Oren, the Israeli ambassador to the U.S., reportedly made such comments to diplomatic staff over the weekend, Israeli newspapers reported.

U.S.-Israeli relations are being tested after Israel announced plans to build 1,600 new apartments in East Jerusalem, which the Palestinians are claiming as the site of their future capital.

In Jerusalem, police were out on the street in the Old City in anticipation of possible clashes.

The announcement was made during a visit to Israel by U.S. Vice-President Joe Biden and came just hours after he had highlighted the closeness in U.S.-Israel relations.

The U.S. has not said publicly what it wants Israel to do about the building plans, but an Israeli official, who spoke on condition of anonymity, said the U.S. wants the construction project cancelled.

The Israeli government did not offer an official comment Monday. Netanyahu has apologized for the timing of the building announcement, but he has not said if it will be scrapped.

George Mitchell, the U.S. government's Mideast envoy, is expected to be back in the region this week in an effort to smooth out relations and salvage Israeli-Palestinian peace efforts.

With files from The Associated Press