US Secretary of State Condoleezza Rice has urged Israel to "give diplomacy a chance" in the standoff over an Israeli soldier held by Palestinian militants.
The Israeli army is on standby for an "extensive" operation
Israeli tanks and troops are massing on the border of Gaza, where it is thought the soldier is being held.
Israeli Prime Minister Ehud Olmert has warned a large scale military operation is rapidly approaching.
"There really needs to be an effort now to try and calm the situation," Ms Rice told reporters en route to Pakistan.
Mr Olmert has refused to release any Palestinian prisoners in exchange for information about tank gunner Gilad Shalit.
He was responding to a demand by three militant groups that women and youths should be freed from Israeli jails.
Intense diplomatic efforts have been under way since the soldier's disappearance, including mediation by an Egyptian delegation in the Gaza Strip.
The BBC's Jon Leyne, in Jerusalem, says that if mediation efforts fail both Israel and the Palestinians face huge tests.
The 19-year-old soldier was seized by militants on Sunday
The Israeli leader must choose between going ahead with military action that would endanger the life of the captured soldier or risk being seen as weak, our correspondent says.
And the Hamas-led Palestinian government must decide whether they are really willing to risk a full-scale attack from the Israelis which could have disastrous consequences.
There are also fears a severe humanitarian crisis and a large numbers of casualties should Israel invades Gaza.
In other developments:
- The Israeli military says it has arrested 43 suspected Palestinian militants in overnight raids across the West Bank
- Egypt has deployed hundreds of riot police along its border with the Gaza Strip to stop any Palestinian attempts to cross illegally in the event of Israeli raids, Reuters news agency reports
- Israeli police says it is taking reports of the abduction of a West Bank settler "very seriously" - one of the groups said to be involved in the capture of Gila Shalit has said it abducted the settler
'Time running out'
Mr Olmert has put the army on standby for an extensive military operation against Palestinian militants to free Cpl Shalit and Israeli tanks and armoured vehicles have been assembling on the Gaza border.
"The question of freeing [Palestinian] prisoners is in no way on the Israeli government agenda," Mr Olmert said during a speech in Jerusalem.
"There will be no negotiations, no bargaining, no agreements."
Mr Olmert said that Israel would not allow itself to become the victim of "Hamas-terrorist blackmail", warning that "a large-scale military operation is approaching".
Cpl Shalit is believed to have been seized by militants who tunnelled out of Gaza to attack the army post at Kerem Shalom.
Two Israeli troops and two militants were killed during the raid.
Hamas political leaders have denied any knowledge of the tank gunner's whereabouts - but they have called for him to be well treated.
The faxed statement calling for the prisoners' release was signed by the Popular Resistance Committees umbrella group, Hamas's Izzedine al-Qassam Brigades, and the previously unknown Army of Islam.
It said: "The Occupation [Israel] will not get any information about its missing soldier until it commits to the following:
"First, the immediate release of all women in prison. Second, the immediate release of all children in prison younger than 18."
Israel is believed to have incarcerated about 100 women and 300 under-18s among the 9,000 Palestinian prisoners it is holding in its jails.
Israeli officials say they hold Palestinian Authority President Mahmoud Abbas and Prime Minister Ismail Haniya, of Hamas, responsible for the 19-year-old Israeli's safety.
Correspondents say the crisis could spoil efforts to bind Hamas into a plan implicitly recognising Israel, and may expose divisions between hardline and more pragmatic Hamas elements.