The Palestinian leadership insists settlement construction must stop
Israeli Prime Minister Benjamin Netanyahu has rebuffed US demands for a total freeze on settlement building in the West Bank.
He is quoted as saying he had told Washington he would instead consider "scaling down construction".
US Mid-East envoy George Mitchell is in the region to finalise terms for renewed peace talks.
The Palestinians have said they will not take part unless Israel stops all construction in its settlements.
The US hopes the Israeli and Palestinian leaders can meet on the sidelines of the UN General Assembly meeting in New York later this month.
After talks with Israeli President Shimon Peres on Sunday, Mr Mitchell said they were working hard to reach agreement on "many outstanding issues".
The US envoy had been set to meet Mr Netanyahu on Monday, but talks were delayed so both men could attend the funeral of an Israeli air force pilot.
Lt Assaf Ramon - son of Ilan Ramon, the Israeli astronaut killed in the 2003 Columbia space shuttle disaster - died when his fighter jet crashed in the West Bank on Sunday.
'Strike a balance'
Mr Netanyahu is reported to have laid out his position on settlement construction to the Knesset's Security and Foreign Affairs committee on Monday.
He told them that Mr Mitchell had requested a complete halt to the building work.
"We made clear that we will build 2,500 housing units which are already in construction," Mr Netanyahu is quoted as saying by a parliamentary official.
"A few days ago, we confirmed 450 additional housing units. I told the Americans that we shall consider scaling down construction."
He said Israel would strike a balance between offering a gesture that would help restart peace negotiations and ensuring a "normal life" for residents in the West Bank settlements.
He also said that any scaling down of construction would be "for a temporary period", not as yet agreed with the Americans.
"The Palestinians expected a complete halt to construction, a freeze, now it is clear that will not be," he went on to say. "Jerusalem is not a settlement, and construction there will continue as usual."
In a statement late Monday, Mr Netanyahu's office said no meeting for peace talks had been set.
But his office added he was ready to move forward a visit to New York, currently set for 23 September, if necessary to enable dialogue.
The US has been preparing a package for peace talks that would see Israel halt settlement construction and Arab nations that have no peace deal with Israel take the first steps towards recognising Israel.
Palestinian leader Mahmoud Abbas insists he will not meet his Israeli counterparts until there is a freeze on the settlement of occupied territory, which is illegal under international law.
When news emerged of Israel's plan to build 450 new homes last week, he said there was no point attending a summit with Mr Netanyahu.
Sabri Seidam, an aide to Mr Abbas, told reporters: "Israel has to stop stalling and focus on creating the atmosphere for a resumption of the peace process.
"Its sole track should lead to the establishment of the Palestinian state."
Regarding other Arab states' recognition of Israel, a former Saudi ambassador to the US, Turki al-Faisal, wrote in the New York Times that diplomatic ties could be renewed "only after they [Israel] have released their grip on Arab lands".
Mr Abbas and the Israel prime minister are due to hold separate talks with Mr Mitchell on Tuesday.
Israeli-Palestinian peace talks have been suspended since December.
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