Israel's relationship with the United States, a defining feature of the troubled Middle East, was under severe strain as diplomats scrambled on Saturday to save newborn U.S.-brokered peace talks with the Palestinians.

A senior U.S. official predicted a dicey period here in the next couple days to a couple of weeks as Palestinians demanded the reversal of a new Israeli settlement plan and Prime Minister Benjamin Netanyahu's coalition, which includes pro-settler parties, reacts to unusually blunt criticism from Washington.

Secretary of State Hillary Clinton called Israel's behavior insulting after it approved 1,600 new homes last week at a settlement in the Jerusalem area on the very day Vice President Joe Biden was there to set a seal on relaunched negotiations.

Biden told Reuters on Friday he believed Netanyahu was sincere in seeking a deal to give the Palestinians a state and that the premier understood that Israel had no alternative.

Though Clinton stressed that Washington's ties with the Jewish state were durable and strong, she had told Netanyahu in a telephone call on Friday that he must act to repair the relationship and show his commitment to an alliance which, she reminded him, was key to Israel's security in a hostile region.

While accepting that Netanyahu was taken by surprise by the settlement housing approval granted on Tuesday by his interior ministry, which is run by the pro-settler religious Shas party, Clinton said the prime minister was still responsible for it.

Her spokesman said she told him it was a deeply negative signal about Israel's approach to the bilateral relationship ... and had undermined trust and confidence in the peace process.

PRO-ISRAEL GROUP STUNNED BY CLINTON

There was no reaction from Israeli officialdom during the Jewish sabbath but in Washington, the Anti-Defamation League, which lobbies for Israel with U.S. lawmakers, called Clinton's remarks on the diplomatic debacle a gross over-reaction.

We are shocked and stunned at the administration's tone and public dressing down of Israel, the ADL's Abraham Foxman said.

We cannot remember an instance when such harsh language was directed at a friend and ally of the United States. One can only wonder how far the U.S. is prepared to go in distancing itself from Israel in order to placate the Palestinians.

Obama is seeking better U.S. relations with the Arab world, which backs the Palestinians, as he seeks to bolster alliances in the oil-producing hub, notably against Iran as it develops nuclear technology and against Islamist enemies like al Qaeda.

Breaking the stalemate on a Palestinian state after 20 years of talking might help challenge Arab perceptions that Washington is in thrall to Israel, some analysts believe, although Israel's strong support in Congress tends to limit U.S. pressure on it.

Aides to Palestinian President Mahmoud Abbas said he was waiting to meet U.S. President Barack Obama's peace envoy George Mitchell when he returns to the region in the coming days before deciding whether to maintain his week-old commitment to starting proximity talks with Netanyahu via U.S. mediators.

PALESTINIANS SEEK SETTLEMENT HALT

Mitchell and the Obama Administration have spent their first year in office pressing the Palestinians to end a suspension of talks dating from Israel's offensive in December 2008 against Abbas's domestic rivals, the Islamist Hamas movement, in Gaza.

Though unhappy with a partial, 10-month settlement freeze in November, Abbas came under even heavier U.S. pressure to return to the table. A week ago, he agreed to four months of indirect talks, aided by endorsement from the Arab League which offered him some political cover from criticisms by Hamas hardliners.

Now, Palestinian negotiator Saeb Erekat, said: President Abbas told the Americans it was going to be very difficult to embark on talks without a cancellation of the Israeli decision to build 1,600 housing units in East Jerusalem and a commitment not to initiate any settlement activities in the future.

A senior U.S. official indicated that Washington may focus on playing down the significance of the past week's approval for future housebuilding -- this was a year away at minimum, he said -- and voicing understanding for Netanyahu's difficulties.

The official described the premier's position as perilous due to his coalition dependence on pro-settler groups.

But he also said Washington expected Netanyahu to avoid a repeat of disputes over settlements: The Israelis know the only way to stay on the positive side of the ledger -- internationally and with us -- is to not have them recurring.

Even the scope of possible talks is still in doubt, however, and few see any rapid prospect of a solution to the conflict.

Israel has so far balked at Palestinian demands that the indirect phase include talks on final status issues, including borders, refugees and sharing the city of Jerusalem.

Washington wants the talks to cover issues of consequence but has yet to spell out publicly what that would entail.

The Quartet of Middle East peace mediators -- the United States, the European Union, the United Nations and Russia -- also condemned the settlement plan and said it would assess the situation at a scheduled meeting in Moscow next week.

(Additional reporting by Adam Entous in Washington, Joseph Nasr in Jerusalem and Ali Sawafta in Ramallah; Editing by Michael Roddy)

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