He called on the Palestinian Authority to "halt terrorism and stop the poisonous incitement against Israelis and Jews" in the official Palestinian media.
The two youths, both aged 14, had been reported missing on Tuesday after skipping school and going hiking outside the Tekoa Jewish settlement near Bethlehem where they lived.
Palestinian-Israeli tensions have risen since a four-month-old baby was killed by Israeli shrapnel during a bombardment of a refugee camp in Gaza on Monday.
Israeli soldiers carrying out the search for the killers arrested four Bedouin shepherds who inhabit the area, witnesses said.
'Terror escalation'
Israeli Prime Minister Ariel Sharon said the "horrifying murders" outside Tekoa amounted to "another escalation in the terrorist activities and violence carried out by the Palestinians against an innocent civilian population".
He called on the Palestinian Authority to "halt terrorism and stop the poisonous incitement against Israelis and Jews" in the official Palestinian media.
Palestinian officials have also condemned the killing; senior negotiator Saeb Erekat said children and civilians were unacceptable targets whether they were Palestinians or Israelis.
"But the short way for peace and stability is finishing the Israeli occupation," he said.
The dead boys have been identified as Yossi Ishran and Kobi Mandel, both them recent arrivals to the settlement. The Mandel family were immigrants from the US.
After the news broke, settlers threw stones at Palestinian cars and the Israeli army sealed off the nearby Arab village of Tuqu, Palestinian security officials said.
On Tuesday, a body of another Israeli settler, who had been shot and stabbed, was found near the settlement of Itamar, south of Nablus.
Clear pattern
The BBC's Middle East correspondent, Frank Gardner, says a clear pattern has been emerging in the latest Israel-Palestinian violence, with Palestinian militants increasingly focusing their attentions on Israeli settlements and those that live in them.
There has also been sporadic violence elsewhere in the Palestinian territories, with two mortar bombs fired at a settlement and a roadside bomb said to have exploded near a passing Israeli army patrol, both in the Gaza Strip.
There are no reports of casualties. The Israel army later launched a raid on Palestinian-controlled land in the northern Gaza Strip destroying a police post.
The settlements on Arab land captured by Israel in 1967 - which are illegal under international law - are one of the major sticking points blocking any long-term peace deal.
Palestinians say there can be no peace with Israel while their land remains under occupation, but Israel's Prime Minister Ariel Sharon has so far refused to consider a freeze on settlement activity while the violence continues.