RAMAT GAN, Israel- Israeli Prime Minister Benjamin Netanyahu responded on Sunday to uncommon pressure from Washington by finally giving his endorsement -- with conditions -- to the establishment of a Palestinian state.

But in a speech answering President Barack Obama's address to the Arab world 10 days ago, the right-wing leader's defense of Jewish settlement on occupied land may fail to dispel tension with the White House, as the two men try to set new terms for the Middle East peace process in their first months in office.

Obama called Netanyahu's shift in position on Palestinian statehood as an important step forward, even as aides to Palestinian President Mahmoud Abbas were denouncing the speech as sabotaging negotiations by restating Israel's refusal to share the city of Jerusalem or accept Palestinian refugees.

Netanyahu, who has refused to back a state for Palestinians since he took office in March, said he would now endorse the establishment of a such a state -- but only if Israel received in advance international guarantees the new nation would have no army and Palestinians recognized Israel as a Jewish state.

If we receive this guarantee regarding demilitarization and Israel's security needs, and if the Palestinians recognize Israel as the state of the Jewish people, then we will be ready in a future peace agreement to reach a solution where a demilitarized Palestinian state exists alongside the Jewish state, Netanyahu said at Bar Ilan University near Tel Aviv.

If (Obama) looks at the glass as half-full, this should be sufficient, Israeli political scientist Eitan Gilboa said of the speech as a whole. But if he is looking for confrontation with Israel, he would say the glass if half-empty.

A senior European diplomat in the Middle East questioned how far it changed the substance of Israel's approach. It's goodwill and good words but I don't think it's going to appease the Americans, the diplomat said. He's trying to gain time.

WHITE HOUSE WELCOME

The president welcomes the important step forward in Prime Minister Netanyahu's speech, the White House said.

The president is committed to two states, a Jewish state of Israel and an independent Palestine, in the historic homeland of both peoples.

Palestinian leaders have rarely made an issue of Israel's insistence that their future state should not have an army in a position to threaten its neighbor, but they have rejected the demand that they explicitly accept Israel as a Jewish state.

To do so, they have argued, weakens the position of the 20 percent of Israel's citizens who are Muslim and Christian Arabs, and undermine a key demand for a right of return to what is now Israel for millions of Palestinians classed as refugees since the flight of Arabs during Israel's creation in 1948.

The White House reference to Obama's support of a Jewish state of Israel may reassure Israelis, who will also hear in his reference to the historic homeland of both peoples an echo of Netanyahu's robust defense on Sunday of the Jews' 3,000-year-old claim to the land and to the city of Jerusalem.

Palestinian leaders voiced their opposition, especially to the Israeli premier's flat rejection of any right of return for refugees or of a division of Jerusalem, where Palestinians want to have the capital of their new state.

Abbas spokesman Nabil Abu Rdainah said: Netanyahu's remarks have sabotaged all initiatives, paralyzed all efforts being made and challenges the Palestinian, Arab and American positions.

Saeb Erekat, who has negotiated interim peace accords, said: The peace process has been moving at the speed of a tortoise. Tonight, Netanyahu has flipped it over on its back.

He reiterated the Palestinian demand that Israel freeze all expansion of the settlements that are home to some half a million Jews in the occupied West Bank and East Jerusalem.

SETTLEMENTS DISPUTE

Obama, too, in what has been the frostiest spell in U.S. relations with Israel in a decade or more, has made a halt to settlements a personal demand. Netanyahu repeated his agreement not to build more settlements but indicated he still wanted to allow what is called natural growth of existing ones.

We have no intention of building new settlements, he said. But there is a need to enable the residents to live normal lives, to allow mothers and fathers to raise their children.

Netanyahu is conscious that a harder crackdown on settlers could fracture his right-leaning coalition government.

The White House did not comment on settlements but did say Obama would ensure all parties fulfill their obligations. Under the 2003 road map to peace, worked out under U.S. sponsorship, Israel committed to freezing settlement activity.

Netanyahu reiterated his readiness to meet all Arab leaders in the region and urged Palestinians to resume peace talks.

It was not immediately clear whether Abbas would accept Netanyahu's call to resume talks. Abbas has made a halt to settlement a condition for renewing negotiations.

With Gaza in the hands of Abbas's Islamist rivals Hamas, who reject interim peace deals and continue to attack Israel, there seems little immediate prospect of ending more than 60 years of conflict. However, diplomats say, engagement by Obama that puts pressure on all sides has raised hopes after years of stalemate.

(Additional reporting by Adam Entous, Dan Williams and Joseph Nasr in Jerusalem and Mohammed Assadi and Ali Sawafta in Ramallah, writing by Jeffrey Heller and Alastair Macdonald in Jerusalem)

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