Mr Obama met with Mr Abbas in the White House
US President Barack Obama has said the situation in Gaza is "unsustainable" and promised millions of dollars in new aid for the territory.
He made the remarks as he met Palestinian leader Mahmoud Abbas in Washington.
The White House visit was scheduled before the deadly Israeli raid on a Gaza-bound aid flotilla last week.
Mr Obama urged both Israel and the Palestinians to make concessions and return to stalled peace talks.
"Not only is the status quo with respect to Gaza unsustainable, but the status quo with respect to the Middle East is unsustainable," Mr Obama said.
"It is time for us to go ahead, move forward on a two-state solution."
He called on the Israeli government to curb the building of Jewish settlements in the West Bank and asked the Palestinians to prevent any actions that could incite confrontation.
Tim Franks, BBC Middle East correspondent
"The game has changed," was how one Western diplomat described it.
Today President Obama became the latest of a long line of major figures to describe the Israeli blockade as "unsustainable". The next big moment is likely to come with a meeting of European Union foreign ministers in Brussels on Monday.
There appears to be a concerted feeling, across the EU - and indeed among the Americans and the United Nations - that this is a chance not just to improve the humanitarian situation, but to re-make the shattered economy of Gaza.
That would involve opening the crossings not only to bring more goods in, but to allow Gazan exports out. There is also talk of trying to persuade Israel to move to a system where it publishes a blacklist of what it refuses to let into Gaza, rather than the current system where it just keeps a private list of what is allowed in.
"Both sides have to create an environment, a climate that will be conducive to an actual breakthrough," Mr Obama said after the meeting.
He said the US would provide $400m (£274m) in new aid for the Palestinians.
Israel says its blockade of Gaza is necessary to deter attacks by militants from the Hamas movement, which runs Gaza.
Mr Abbas, who is president of the Palestinian Authority, arrived in Washington on Tuesday from Turkey, which fiercely condemned the 31 May Gaza flotilla raid that killed nine Turkish activists.
During his visit, Mr Abbas is also due to meet National Security Adviser James Jones and some members of Congress.
Wednesday's talks come a week after Israeli Prime Minister Benjamin Netanyahu cancelled his own White House trip, in order to deal with the fallout from the Gaza crisis.
Indirect US-mediated talks between the Israelis and the Palestinians resumed in May after a break of nearly two years.
The two sides are negotiating through US envoy George Mitchell, in so-called proximity talks.
The discussions are due to last four months, and are meant to address some core issues: borders, Jerusalem and refugees.