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The U.S. administration has issued a stiff warning to Israel not to build in the area known as E-1, which lies between Jerusalem and the West Bank settlement of Ma'aleh Adumim. Any change in the status quo in E-1 would be "extremely damaging," even "corrosive," the message said.

Prime Minister Benjamin Netanyahu has vowed in the past to finally build the controversial E-1 housing project - as have several premiers before him, though none has done so due to American pressure. He opened his recent election campaign with a visit to Ma'aleh Adumim in which he declared: "I will link Jerusalem to Ma'aleh Adumim via the Mevasseret Adumim neighborhood, E-1. I want to see one continuous string of built-up Jewish neighborhoods."

He has also warned in the past that failure to build in E-1 would allow the Palestinians to create territorial contiguity around Jerusalem.

Just before his government was installed this spring, the media reported that Netanyahu had reached an agreement with his largest coalition partner, Yisrael Beiteinu, to unfreeze construction in E-1. However, that clause was ultimately not included in the coalition agreement.

The plans for E-1 call for building 3,500 housing units, along with commercial areas and tourism sites, to create a single urban expanse stretching from Jerusalem to Ma'aleh Adumim and strengthen Israel's hold on East Jerusalem, which would then be completely surrounded by Jewish neighborhoods.

The United States has always vehemently opposed this plan, fearing it would deprive a future Palestinian state of territorial contiguity, cut the West Bank in two and sever East Jerusalem from the rest of the West Bank - all of which would thwart any hope of signing a final-status agreement and establishing a Palestinian state.

President Barack Obama's predecessor, George W. Bush, vigorously opposed building in E-1 during the terms of prime ministers Ariel Sharon and Ehud Olmert. Sharon did approve construction of a police station in E-1, and under Olmert, infrastructure work in the area continued. But neither ever approved construction of either the residential units or the commercial buildings, for fear of a confrontation with the United States.

Four years ago, after resigning from Sharon's government, Netanyahu attacked him for giving in to American pressure on E-1. "A sovereign government must build in its eternal capital," he said. "Sharon set a precedent that will lead to the division of Jerusalem."

The Obama's administration - which opposes all construction in East Jerusalem, even of a few houses - would be even more outraged by a large-scale project such as E-1.

It is demanding a moratorium on Jewish building in East Jerusalem until an agreement is reached on the city's legal status, arguing that the cumulative effect of even small-scale projects would destroy any chance of a peace agreement and arouse fierce opposition in the Arab world, especially among East Jerusalem Arabs. Small projects include the construction of 20 apartments in the Shepherd Hotel in the Sheikh Jarrah neighborhood or plans to build new Jewish housing in Silwan.

At Sunday's cabinet meeting, however, Netanyahu rejected this American stance. "United Jerusalem is the capital of the Jewish people and the State of Israel. Our sovereignty in it is not subject to appeal, and among other things, this means that Jerusalem residents can buy apartments anywhere in the city," he said. "We cannot accept the idea that Jews should not have the right to live and buy anywhere in Jerusalem."

Next week, three senior American officials will visit Israel: special envoy George Mitchell, National Security Advisor James Jones and Secretary of Defense Robert Gates. Mitchell will continue his efforts to reach agreement on a settlement freeze, including in East Jerusalem, while the other two will focus on the Iranian threat.