NSW Planning Minister Paul Scully has forced the City of Sydney's Town Hall project to pause work on the development.
Sydney Deputy Lord Mayor Jess Miller is disappointed by the sudden halt to the project, which has been in train since the city bought land for the project in the 1980s.
The Independent Planning Commission will advise whether or not the project should be considered a state development.
NSW Planning Minister Paul Scully has hit the brakes on the City of Sydney's $150 million Town Hall Square project, forcing the project to be examined by the Independent Planning Commission.
Mr Scully issued a direction to the council on Thursday, preventing it from determining development applications or demolition orders in relation to the project.
The council envisages a 4,500-square-metre civic plaza opposite Town Hall as a gathering point for community events, music events and markets.
Speaking with 702 ABC Sydney, Mr Scully said he believed it could be considered a "state significant development", given the cost of the project and the demolition of "cultural and commercially" buildings.
"I want to get that advice from the Independent Planning Commission. That's the requirement of me under the act [Environmental Planning & Assessment Act]."
City of Sydney Deputy Mayor Jess Miller criticized the decision as "disappointing", arguing the council had planned the project for a long time.
"We're going to have a huge increase of population in the city of Sydney. We're going to need new public squares," she told 702 ABC Sydney.
"It's been done thoughtfully. We've saved up our pennies.
"We've done all the right things and to have the kind of state significant magic wand kind of waved over this is really awful."
Plans for the square have been on display for community feedback since early August, with artist impressions showing the open square with a water feature and a curved grove of native trees.
The council resolved in February this year to move ahead with the design and construction of the square, with an unanimous decision to fast-track demolition work of the buildings on land the city has obtained since the 1980s.
The proposal has drawn opposition from the retail workers union, which argues the demolition of seven buildings, including a Woolworths supermarket, retail stores and a pub, will put 1,000 jobs at risk.
Shop, Distributive and Allied Employees Association NSW state secretary Bernie Smith said 300 of those jobs were in the Woolworths and Big W on the corner building.
"There's not a suitable floor space currently available to relocate that shop, as far as we are aware, that would actually preserve all of those jobs," Mr Smith said.
Cr Miller told 702 ABC Sydney the supermarket would be able to find an alternative location "200 metres down the road".
"Of all of my sympathies, they're not being extended to one of the biggest multinational or big corporate companies," she said.
Mr Smith responded at Cr Miller's comments, saying the deputy mayor should "spend less time in Town Hall and maybe a bite more time in her community to realise what's really going on across the road".
Advocacy group Business Sydney head Paul Nicolau, who opposes the plan, said the supermarket was the only full-service kind in the CBD and was "vital to the future of a city where more people are choosing to live".
"Thoughts of a Town Hall Square might have been a nice-to-have when the concept was first mooted more than 30 years ago," Mr Nicolau said.
"But the economic realities of 2026 are very different."
Both Mr Nicolau and Mr Smith supported the government's move to have it assessed by the planning commission.