Vettel led a Ferrari one-two in second practice at Sochi - after team-mate Kimi Raikkonen topped the opening session - while the best of the Mercedes drivers, Valtteri Bottas, was 0.67 seconds off the pace in third.
Hamilton was three-hundredths of a second slower than Bottas, which led Vettel to suggest Mercedes was holding back, something Hamilton has refuted.
"We never sandbag," he said. "There's no benefit to sandbagging, ever.
"I think Ferrari has done in the past but there is zero benefit for us to do so, we're trying to get the car to the optimum balance-wise and today's generally been a tricky day.
"I don't know why he would suggest that, it's just Sebastian trying to blow smoke our way. Really, those guys are just very quick."
Mercedes team boss Toto Wolff said on Friday that Ferrari's pace was proving more "robust" because its 2017 car was working well in a wider range of conditions.
Read the full article on eurosport.co.uk: Hamilton rejects Vettel's 'sandbagging' claim as Ferrari take one-two in Sochi practice