android studio 1.7,如何在Android Studio和Gradle中设置-source 1.7

I'm getting following error when trying to compile my project in Android Studio:

Gradle: error: diamond operator is not supported in -source 1.6

I have 1.7 set as target in all project preferences I've found. Also the path displayed in project SDK's under 1.7 SDK is correct path to java 1.7 installation.

Even when I run java -version in terminal, it tells me I'm running on java 1.7.

I have tried to set JAVA_HOME env variable to this:

/Library/Java/JavaVirtualMachines/jdk1.7.0_25.jdk/Contents/Home

The error does not go away. How do I eliminate the error?