Israeli Prime Minister Ehud Olmert will devote the next year to pursuing peace with the Palestinians, he has told Israeli MPs.
The Palestinian leadership of Mahmoud Abbas was serious about reaching a deal, he said.
To angry heckling from opposition MPs, he said the goodwill of Mr Abbas's Western-leaning Palestinian government must not be squandered.
He would not, he said, seek "excuses in order to avoid a peace process".
"I do not intend to look for excuses in order to avoid a peace process"
Palestinian negotiator Saeb Erekat welcomed Mr Olmert's remarks and said they emphasised the need to move quickly.
"Everyone, including Mr Olmert, realizes that time is of the essence, and that it's time for decisions," he said.
While Mr Abbas's government controls the West Bank, the Gaza Strip remains in control of its Palestinian rival, Hamas.
Mutual trust
Speaking at the opening of parliament's winter session, Mr Olmert said an atmosphere of mutual trust had been nurtured during a series of recent one-on-one meetings with President Abbas, although he conceded no firm steps had yet had been agreed.
"Israel has an interest to get recognition of all of Jerusalem's Jewish neighbourhoods, and to hand over control of Arab neighbourhoods to the Palestinians"
He warned that the alternative to the peace process was a "bloody and tearful demographic struggle which will not serve Israel".
Israel, he added, would have to give up some of its deepest desires in order to build a future of peace and security.
The statement prompted an angry response from opposition MPs demanding whether he planned to cede sovereignty of certain parts of Jerusalem to the Palestinians.
Opposition leader Benjamin Netanyahu argued that conceding control of East Jerusalem to the Palestinians would pose a deadly threat to the Jews living in the western part of the city.
"If Israel leaves it will open the door to al-Qaeda," he said.
Earlier, Israeli Vice-Premier Haim Ramon said the future status of Jerusalem would be on the agenda at next month's planned Middle East peace conference.
Palestinians want the talks to tackle "final-status" issues, including Jerusalem, though Israel is reluctant.
Israel occupied East Jerusalem, now home to 240,000 Palestinians, in 1967.
Dividing the Holy City
Since its victory in the 1967 Arab-Israeli war, it has settled hundreds of thousands of its citizens there and claims the entire city as its "eternal, indivisible" capital.
"Israel has an interest to get recognition of all of Jerusalem's Jewish neighbourhoods, and to hand over control of Arab neighbourhoods to the Palestinians," Mr Ramon said.
"When we speak of a diplomatic horizon, these are the subjects we are referring to."
However, he said Israel would not transfer control of the Old City with its holy places and surrounding neighbourhoods to the Palestinians.
Mr Ramon has previously backed "special sovereignty" over the city's holy sites, while the Western Wall and Jewish Quarter would come under Israeli sovereignty.
The Kadima party of Mr Ramon and Prime Minister Ehud Olmert won last year's elections with a programme that favoured unilaterally demarcating Israel's borders with the Palestinians.
Kadima colleagues have criticised his position, arguing that the whole of Jerusalem must remain under Israeli control.
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