More than 2,000 Israeli police had been deployed around the compound to step up security after two days of confrontation.
Israeli police have denied access to Muslim men aged under 45 and Palestinians from the West Bank to the al-Aqsa mosque compound, Islam's third-holiest site.
Israeli officials have insisted the work, expected to take months, poses no risk to the holy sites and will strengthen an access ramp for the "benefit and safety of visitors" after an earthquake and snowstorm damage in 2004.
Despite the street protests and dissent from within his own governing coalition, Ehud Olmert, the Israeli prime minister, refused on Sunday to call off the renovations.
"Work will continue because it is a question of fixing a dangerous situation," he said at his weekly cabinet meeting, according to army radio.
"The building site is not on the mosque compound and does not offend the sensitivities of Muslims."
Leaders of Israel's left-leaning Labour party had called for the work to halt after rioting on Friday and again on Saturday. Minor scuffles took place outside the mosque on Sunday.
The clashes have come ahead of a February 19 summit between Condoleezza Rice, the US secretary of state, Mahmoud Abbas, the Palestinian president, and Olmert as the West redoubles its efforts to revive the stagnant Middle East peace process.
The fate of Jerusalem and its holy sites is one of the most contentious issues in the Israeli-Palestinian conflict and has a history of triggering unrest across the Holy Land far beyond the confines of the Old City walls.
It was at the compound that the second Palestinian uprising against the Israeli occupation started in September 2000 after a visit by Ariel Sharon, the then Israeli opposition leader.