Increasingly fractious relations between the US and Israel hit a low unseen in nearly two decades today after the Jewish state rejected President Obama's demand for an end to settlement construction in the West Bank and Washington threatened to "press the point".

The dispute, which blew in to the open hours before Obama was to meet the Palestinian leader, Mahmoud Abbas, reflects the depth of the shift in American policy away from accommodating Israel to pressuring it to end years of stalling serious negotiations over the creation of a Palestinian state while continuing to grab land in the occupied territories.

Obama put down a marker at a difficult meeting with the Israeli prime

minister, Binyamin Netanyahu, in Washington this month when he demanded a halt to the perpetual expansion of settlements - which now house close to 500,000 Jews in the West Bank and occupied East Jerusalem - because they are a major obstacle to the establishment of an independent Palestine.

The US secretary of state, Hillary Clinton, pressed the point yesterday with an unusually blunt call for a halt to settlement growth, including the continued construction of so-called "outposts", small informal settlements which are illegal even under Israeli law, as well as the building of new houses in existing Jewish enclaves which the government describes as "natural growth".

Clinton said Obama "wants to see a stop to settlements - not some settlements, not outposts, not natural growth exceptions. We think it is in the best interests of the effort that we are engaged in that settlement expansion cease." She said the Americans "intend to press that point".

Israel is committed to stop all settlement construction under the 2003 US road map to peace.

Today the Israeli government spokesman, Mark Regev, said that construction will continue inside existing settlements.

"Israel ... will abide by its commitments not to build new settlements and to dismantle unauthorised outposts," he said. "As to existing settlements, their fate will be determined in final status negotiations between Israel and the Palestinians. In the interim period, normal life must be allowed to continue in these communities."

Israel defines normal life as the construction of homes to accommodate the children of Jewish settlers when they grow up and marry. Critics say that almost nowhere else in the world is it considered a right to build a house next to your parents house.

Netanyahu has offered to remove 26 of more than 120 outpost settlements but both the US and Palestinians remain sceptical about Israeli commitments as similar promises have been made over recent years and repeatedly broken.

The former prime minister, Ariel Sharon, promised President George Bush to his face that the outposts would come down but instead the Israeli government continued to allow new ones to be constructed, often with the assistance of the military and other state authorities.

Settlements have long been viewed as a litmus test of Israel's intent. Even at the height of the Oslo peace process, Israel more than doubled the number of Jews it moved to live in the West Bank, raising fundamental questions among the Palestinians as to whether Israel was more interested in grabbing land than peace.

The dispute over settlements, and Netanyahu's defiance of Obama's call, is likely to set the tone for future relations as the White House attempts to radically change the US approach by pressing Israel to move swiftly toward serious negotiations to end the occupation and establish an independent Palestinian state.

Robert Malley, former special assistant for Arab-Israeli affairs to Clinton, said: "The surprise in this is not the Israeli position. The surprise the forcefulness of the American one. Rarely have we seen it at this pace and with this intensity and unambiguity. The US has taken a position that doesn't give much wriggle room at all to the Israeli government".

But Malley said it remains unclear how far the White House will press Israel.

Some US analysts say that the settlement issue is a good one for Obama to use to press Netanyahu because even among Israel's supporters in Congress there is not much backing for the continued expansion of Jewish enclaves in the Palestinian territories.

Other analysts say Obama will have to be careful not to allow a protracted dispute over the settlements to stall broader talks on the creation of a Palestinian state.

But questions remain over how far Obama is prepared to push Israel when Congress remains strongly sympathetic to the Jewish state and the pro- Israel lobby continues to wield powerful influence.

Obama's public stand on settlements is also intended to strengthen Abbas who is politically weak and under pressure from Hamas. Palestinian officials say Abbas plans to raise the settlement issue as one of the major obstacles to the peace process.

Israel's intelligence minister, Dan Meridor, met in London earlier this week with the US Middle East envoy, George Mitchell, for follow up meetings after Netanyahu's Washington visit at which the settlement issue was also pressed.