The veto came as Security Council was preparing for an emergency debate on Saturday to discuss the escalating violence in Lebanon.
The Lebanese government has requested tomorrow’s debate and called on the Council to "adopt a complete and immediate position for a ceasefire."
Meanwhile US Ambassador John Bolton said the Gaza veto was a response to the "unbalanced" nature of the draft text which he argued laid a disproportionate amount of blame on Israel for the current crisis in the region.
"Passage would have undermined the credibility of the Security Council, which itself must be seen by both sides as an honest broker in the Middle East conflict," Ambassador Bolton said.
Ten of the 15-member council voted in favour of the proposed resolution, drafted by Qatar, while four abstained.
The vote came hours after Israeli air strikes on the Palestinian foreign ministry in Gaza, which caused heavy damage and wounded 10 children.
Growing crisis
What has become the worst Israeli-Palestinian crisis in months was sparked by the June 25 abduction by Palestinian militant groups, including the armed wing of Hamas, of Corporal Gilad Shalit on the Gaza border.
The vetoed resolution condemned Israel's retaliatory assault and called for an end to military operations and the immediate withdrawal of Israeli troops.
It also condemned the firing of rockets from Gaza into Israel and Corporal Shalit's abduction.
The US is Israel's staunchest ally and last used its veto in the Security Council in October 2004 to block a similar draft demanding that Israel end military operations in northern Gaza and withdraw from the area.
Mr Bolton said the United States remained convinced that the best way to resolve the immediate crisis was for Hamas to secure Shalit's "safe and unconditional" release.
Israel's ambassador to the UN, Dan Gillerman, hailed the "bold" US stand in blocking the Qatari resolution and defended Israeli operations in both Gaza and Lebanon as acts of justifiable self-defence.
"Israel will not be held hostage to terror," Mr Gillerman told Council members. He also accused Hamas and Hezbollah militants as acting like "executioners" for Iran and Syria.
The Palestinian observer to the UN, Ryad Mansour, slammed the US veto, saying it would do nothing to resolve the current crisis.
"We are highly disappointed and frustrated at the council's continued inability to act while innocent Palestinian civilians continue to be brutally killed by the Israeli occupying forces," Mr Mansour said.
UN mission
Just hours before the Security Council vote, UN Secretary General Kofi Annan announced that he was sending a three-man crisis team, led by his special political adviser, Vijay Nambiar, to try and defuse the situation in the Middle East.
Speaking in Rome Mr Annan told reporters that he was "profoundly worried" by the increase in violence and condemned any attacks on civilians.
Mr Annan's team will undertake a week-long mission in the region that will begin in Cairo with meetings with Egyptian officials and Arab League foreign ministers.
They are then expected to travel to Israel, the Palestinian territories, Lebanon and Syria.
Mr Annan's deputy spokesperson Marie Okabe said the secretary general had been working the phones with all the major players in the region, including the Syrian and Egyptian presidents and Israeli Prime Minister Ehud Olmert.