Israel's ambassador to the United States Michael Oren is reported to have described relations between the countries as facing a crisis of historic proportions.
Israeli Prime Minister Benjamin Netanyahu tried to play down the row at the weekend, saying he regretted the fact an announcement about construction in occupied East Jerusalem had been made during a visit by the US vice-president Joe Biden.
The Americans are still furious at what they describe as an insult - one that could sabotage the talks they have so carefully put together with Israel and the Palestinians, the BBC reports.
The Palestinians are saying that the project for 1600 new homes on occupied land must be cancelled before negotiations can begin.
The decision on the new building did not come directly from Mr Netanyahu, but from right-wing elements in his governing coalition.
However, the BBC reports Mr Netanyahu is now learning the lesson that even Israel cannot humiliate the US vice-president on an official visit and expect to get away with it.