A trilateral meeting on the GA sidelines was seen as a hollow photo opportunity
US President Barack Obama has called for an immediate re-launching of Middle East peace talks without preconditions, during his maiden address to the UN.
Palestinian leaders voiced frustration that the US appeared to be softening a demand that Israel stop all settlement activity in the occupied West Bank.
At at trilateral meeting on Tuesday, Mr Obama urged Israel to "restrain" construction rather than end it.
But Mr Obama said the US still viewed settlement activity as illegitimate.
Israeli leaders expressed satisfaction with the outcome of the meeting, but a senior Palestinian official was quoted as saying the Obama administration had retreated on promises to the Palestinians at the expense of peace.
"The time has come to re-launch negotiations - without preconditions - that address the permanent-status issues: security... borders, refugees and Jerusalem," Mr Obama said at the annual UN General Assembly in New York.
He also spoke about the need to break old patterns, in which the US backed Israeli security without insisting it respect legitimate Palestinian rights.
And he condemned some UN member states for "choos[ing] vitriolic attacks" against Israel rather than recognising its "legitimacy and its right to exist in peace and security".
A few moments earlier he had reiterated that the US "does not accept the legitimacy of continued Israeli settlements".
The speech followed a difficult period for US diplomacy, as intensive efforts failed to get the two sides to renew negotiations, which have been suspended since December.
Former Palestinian security chief Mohammad Dahlan said the Palestinians might refuse to accept an invitation from Mr Obama to return negotiations without a freeze in settlements.
"The US administration has retreated from its position at the expense of peace," he told Reuters news agency.
Another official, Nabil Shaath, said the Palestinians still hoped that Mr Obama would put pressure on Israel to stop building on land it had occupied in the 1967 war.
Israeli Foreign Minister Avigdor Lieberman said it was clear Israel had not given in to pressure over settlements, and that peace talks could now re-start without it having to do so.
Israeli Prime Minister Benjamin Netanyahu and Palestinian leader Mahmoud Abbas shook hands in Mr Obama's presence at a New York hotel during their first encounter since Mr Netanyahu came to office in March.
Some commentators described the meeting as a hollow photo-call in sharp contrast to the substantive peace negotiations that US had been trying to launch during the UN General Assembly.
The US had been pressuring Israel to comply with Palestinian demands for all building in settlements in the occupied West Bank to end before talks restart.
Israel has repeatedly rejected US and Palestinian demands for a total building freeze in settlements, which house about 500,000 Jews among about 2.5m Palestinians in the Israeli-occupied West Bank and East Jerusalem.
Mr Netanyahu has previously offered a temporary construction freeze for several months, but not in East Jerusalem or in cases where homes had already been approved.
The Israeli prime minister argues that the "natural growth" of settler families must be accommodated.
Hamas, a rival to Mr Abbas's Fatah party, which controls the Gaza Strip, condemned the talks as "cover for Israeli aggression". Meanwhile, Israeli settlers opposed to a settlement freeze set up a protest tent in Jerusalem.
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