At the heart of Jerusalem's Palestinian neighborhood, where Suleiman and Salah al-Din streets meet near the Old City walls, the most imposing building houses Israeli police and government offices.

Soldiers in flak jackets who mingle with the Palestinians outside underline Israel's claim to rule the entire city, which was reunited and expanded after Israel captured the Arab sector from Jordan in the 1967 Middle East war. As negotiations over final borders between Israel and a nascent Palestinian state begin, Israeli officials insist they will never cede control over any part of the city, which is central to Jewish history and which they have declared Israel's capital forevermore.

But beneath that uncompromising stand, and despite the presence of Israeli police, a gap is opening between Israel's policy of eternal control over the entire city and the quiet but growing power of Palestinian officials over the daily lives of the Palestinian residents.

In apparent violation of agreements with Israel to maintain the status quo, Palestinian officials are surreptitiously extending their control over many facets of everyday life in the parts of East Jerusalem where almost all the city's Palestinians live. Appointees of Yasser Arafat, who heads the Palestinian Authority based in Gaza and nearby Ramallah, now claim to run what is in some respects a parallel city administration, with some degree of control over schools, public property, medical services and even security.

Although Israel retains overall authority in Jerusalem, particularly for security, the spreading activities and authority of Palestinian officials erodes Israel's day-to-day sovereignty. Because of this, some Israeli officials say privately that they eventually could be forced to accept Palestinian civilian authority in parts of the city, keeping Israeli rule in those neighborhoods only for security issues.

That formula--Israeli sovereignty and security coupled with Palestinian administration for Arab neighborhoods--could also provide one possible compromise for the two sides' seemingly irreconcilable claims to the city.

"Israel's political leadership still tells the people that we control all of Jerusalem, but that is not true any more," said a senior Israeli military intelligence official. "East Jerusalem is gone. We lost it bit by bit. We will not get it back now without a long, bloody campaign the West will not allow."

Jamil Nasser is the Palestinian official who calls himself the governor of Jerusalem. His office is in the village of Abu Dis, just outside the city limits, across from a newly renovated building housing an elite Palestinian police unit. Above his desk is a huge photograph of Arafat. It leaves no doubt whom he works for.

"Part of my job is to create facts on the ground to help our negotiators regain sovereignty over Jerusalem," he said, in a building buzzing with assistants, clerks, bodyguards and Palestinians from East Jerusalem coming to record property deeds and settle business disputes.

"Technically, our sovereignty is still in question, but we have the power to do many, many things--more every day," he said. "The people give us that authority."

Jerusalem's mayor, Ehud Olmert, was elected without the votes of Palestinians in East Jerusalem, because they boycott Israeli-run municipal elections. Even so, he insisted he has complete authority in the city, including on the Palestinian side.

"Palestinian officials have only a superficial presence," he said. "To say they can determine critical events is not true."

Olmert acknowledged Israel has grossly neglected city services for East Jerusalem, creating great resentment. But he said that is being corrected and most residents prefer the Israeli administration to a Palestinian one.

Still, building on national, religious and social ties, the power of the Palestinian Authority appears to be growing in a number of critical ways. Ignoring Israeli law, plainclothes Palestinian police have greatly increased their activities in East Jerusalem, according to Israeli intelligence officers and Palestinian officials. The police often enforce the rulings of Palestinian officials like Nasser and sometimes take residents for interrogation to areas under Palestinian Authority control, according to Israeli security officials and Palestinian human rights groups.

Much of the curriculum in public schools is controlled by the Palestinian Authority, schoolteachers said. And the director of the largest hospital in East Jerusalem said the Palestinian Authority pays for most of his budget.

Palestinian Authority officials said they also control the important Islamic institution called the Wafq, the religious trust that owns much of the land in East Jerusalem and controls Islam's third-holiest place, the site of the Al Aqsa Mosque and the Dome of the Rock. Wafq officials also dominate the important religious court that rules on personal matters like marriages, divorces and inheritances, using traditional Islamic standards. Israel does not recognize the decisions of the court, but Palestinians go there anyway.

In repeated agreements brokered by the United States, Israel and the Palestinians have promised not to make unilateral changes in areas under dispute. Which side would control Jerusalem, for instance, is supposed to be decided through negotiations. Even so, Israel has expanded its presence in traditionally Arab parts of the city by building tens of thousands of housing units for Jews. At the same time, Israeli authorities have followed a policy that makes it difficult for Palestinians to stay in the city by routinely denying them home-building permits.

Israel's intention was to increase domination of Jerusalem by making its population overwhelmingly Jewish, according Amir Chesin, the former chief adviser on Palestinian affairs for the city of Jerusalem. "Jerusalem is our capital," he said. "It has to consist of a majority of Jews. A big majority."

That policy has been carried out aggressively. Even in traditionally Arab East Jerusalem, there is now a Jewish majority.

Today, 33 years after Israel seized the Jordanian-run part of Jerusalem and expanded city boundaries, about 630,000 people reside within the new city limits, about 200,000 of them Palestinian. The Palestinians receive just over 10 percent of the municipal budget for services and infrastructure, according to B'Tselem, an Israeli human rights organization.

Publicly, top Palestinian officials are eager to play down any increase in their power because they admit they are reneging on agreements. A senior Palestinian official, speaking on condition he not be named, described the agreements on Jerusalem as only "tactical steps toward liberation" of the city, rather than commitments to be honored.

"We are in a war of national survival, survival of the Palestinian people. If you see it that way then what we are doing is okay," he said.

This leaves a situation in which Israeli officials join ranking Palestinian officials in maintaining that there has been little change in control. At the same time, Israeli and Palestinian security officials, foreign diplomats and Palestinian residents of Jerusalem say the Palestinian part of the city has in many ways maintained its separation.

Palestinians in East Jerusalem still get Israeli national health insurance and retirement benefits, they still pay taxes to Israel and use its public utilities. But that only gives Israel "symbolic sovereignty, not control," said Menachem Klein, an Israeli academic.

In the close quarters of the stone pathways in the Old City, Palestinian merchants said they barely consider turning to Israel for most important matters. The Islamic Wafq is their landlord. Most questions that could go before Israeli courts are resolved by the leaders of the Islamic court, local elders or Palestinian officials like Nasser.

For police, they said they prefer to look to Arafat. "The Israeli police are here to occupy Palestine, not to help Palestinians," said Ahmed Abu Ziad, who sells dried spices and nuts. "I asked then to stop the pickpockets near the store; they did nothing. Then I asked for help from our police, Palestinian police. They are here every day."