The decision, made during the cabinet meeting on Sunday, brought a stinging rebuke from Jewish organizations in Israel and around the world.
In freezing the plan, Netanyahu backed away from an agreement reached in January 2016 after five years of negotiations, in which a space where men and women could pray together would be established at the southern end of the Western Wall.
But Netanyahu never implemented the agreement because of pressure from the ultra-Orthodox parties in his government. Currently, men and women pray separately, following the strict rules of Orthodox Judaism.
The move risks driving a deep wedge between Israel, which recognizes Orthodox Judaism, and more liberal streams of Judaism, such as Conservative and Reform Judaism, which make up the majority of the world's Jews.
Rabbi Rick Jacobs of the Union for Reform Judaism called it an "unconscionable insult to the majority of world Jewry." Yizhar Hess, the executive director of the Conservative movement in Israel said, "Nothing like this has ever happened before."
Knesset member Michael Oren blasted the decision, saying, "This move undermines the very foundations of Zionism."
But Rabbi Yaakov Litzman, head of the ultra-Orthodox United Torah Judaism party, lauded Netanyahu's decision, saying it was important for "the future of the Jews."
Litzman warned that Conservative and Reform Judaism, which have a more liberal interpretation of the religion, are "harming Judaism and tearing the Jewish nation to bits and threaten a terrible assimilation that we are unfortunately aware of outside of Israel."
In an unprecedented step, the Jewish Agency's Board of Governors cancelled a dinner with Netanyahu. Natan Sharansky, chairman of the Jewish Agency and a key architect of the agreement, said, "Today's decision signifies a retreat from that agreement and will make our work to bring Israel and the Jewish world closer together increasingly more difficult."
Rabbi Gilad Kariv, president and CEO of the Israel Reform Movement, directed his anger squarely at Netanyahu. "The Prime Minister and his coalition partners actively gave their blessing to this anti-Zionist step that will hurt the relations between Israel and the Diaspora, and weaken the connection of millions of Jews to Jerusalem."
Prime Minister Netanyahu did not comment on the decision to pull back from the agreement.
The leader of the ultra-Orthodox Shas party, Aryeh Deri, praised the freezing of the agreement. "There is no doubt that maintaining the status quo with the subject of the Wall reflects the desire of the majority of the nation that sees the Western Wall as the most holy place for the Jewish people and not a place for destructive elements whose total objective is to desecrate the place."
The two ultra-Orthodox parties control only 13 seats out of 120 in the Knesset, Israel's parliament, but they make up a more substantial part of Netanyahu's 66-seat coalition. That allows them to make demands on Netanyahu, since they have enough seats to topple the coalition and threaten new elections. Although they almost always back the Prime Minister, their main concern is matters of religion, such as the status of the Western Wall.
Women of the Wall, an organization that advocates for freedom of prayer at the Western Wall, promised to keep "praying according to our conscience."
Anat Hoffman, chairperson for Women of the Wall, said, "It's a terrible day for women in Israel when the Prime Minister sacrifices their rights while kowtowing to a handful of religious extremists, who want to enforce their religious customs while intentionally violating the rights of the majority of the Jewish world."
The government will try to reach a new agreement on prayer at the Western Wall, led by one of Netanyahu's closest ministers.