Chancellor Angela Merkel reportedly chastised Prime Minister Netanyahu during Friday's call, telling him she had "absolutely no understanding" of Israel's decision to approve new settlement construction.
Israeli media said the exchange showed relations with Germany were in deep crisis, but Netanyahu's office denied that in a statement on Sunday.
"Relations with the German government and Chancellor Angela Merkel are good and very close. When differences emerge they are discussed in a positive way," the statement said.
But reports about the phone call, which came after Israel approved the construction of 1,100 new homes in the east Jerusalem settlement neighbourhood of Gilo, suggested ties have frayed.
In Berlin, Merkel's spokesman Steffen Seibert confirmed that the German leader had questioned Israel's commitment to peace talks in the wake of its decision to announce the new construction.
"This approval had raised doubt whether the Israeli government has an interest in the start of serious negotiations," he said, adding that Merkel told Netanyahu it was "now a question of dispelling this doubt."
Israeli newspaper Haaretz, citing unidentified German officials, described the tone of the call as angry, saying Merkel was "furious" and "does not believe a word (Netanyahu) says."
The settlement construction announcement came shortly after the international peacemaking Quartet issued a proposal for a resumption of peace talks, calling for negotiations to begin within one month and a deal to be reached before the end of 2012.
The grouping, composed of the United States, United Nations, European Union and Russia, also warned both Israel and the Palestinians to avoid provocative actions that could torpedo the chances of talks resuming.
Haaretz said Merkel made explicit reference to the Quartet's warning.
"I cannot understand how just a few days after the Quartet statement you approve 1,100 new housing units," the newspaper quoted her as telling Netanyahu.