JERUSALEM - Prime Minister Benjamin Netanyahu said on Monday Israel would not freeze all building in West Bank settlements as demanded by Washington but could limit its scope to help to restart peace talks with the Palestinians.

Israeli officials have said work would continue on 2,500 settler homes being built in the occupied territory, and Netanyahu reaffirmed the position in remarks to a legislative panel, before talks on Tuesday with a U.S. envoy.

They (Americans) asked us for a complete freeze and we told them that we will not do this, Netanyahu was quoted as saying by a parliamentary official, who briefed reporters on his comments to the Foreign Affairs and Defense Committee.

I told the Americans we would consider reducing the scope of construction, the Israeli leader said, according to the official.

But there has to be a balance between the desire to make progress in political negotiations and the need to allow inhabitants of Judea and Samaria to continue to lead normal lives, Netanyahu said, referring to the occupied West Bank.

Israel Radio quoted Netanyahu, who heads a right-leaning government, as saying any construction restrictions would be in effect only for a limited time, but said he gave no timeframe.

Palestinian President Mahmoud Abbas, also due to meet U.S. presidential envoy George Mitchell on Tuesday, has said he would not return to peace negotiations with Israel until it froze settlement activity in line with a 2003 peace road map.

Talks have been suspended since December.

At its weekly meeting, the Palestinian cabinet demanded Israel agree to a comprehensive halt to settlement activities including 'natural growth', a term that refers to construction to accommodate growing settler families.

PACKAGE DEAL

Mitchell, who arrived in Israel on Saturday, has been trying to prepare a package under which Israel would halt construction in settlements and Arab nations would take initial steps toward recognizing Israel.

Washington hopes both moves would lead to a resumption of peace talks. Mitchell and Netanyahu said separately on Sunday gaps still needed to be bridged before a settlement deal could be sealed.

In an opinion piece published in The New York Times on Monday, Turki al-Faisal, a former director of Saudi Arabia's intelligence services, said regional recognition of Israel could come about only after it removed all settlements.

We are willing to embrace the hands of any partner in peace, but only after they have released their grip on Arab lands, he wrote.

Last week, Israeli Defense Minister Ehud Barak drew a U.S. rebuke by approving 455 building permits in settlements in the West Bank, land Israel captured in a 1967 war and which Palestinians want as part of a future state.

The move was widely seen in Israel as a bid to placate settlers before any construction limitations. An Israeli government official said it was a step toward a package deal that could include very severe limitations in the growth of settlements -- a possible moratorium.
Some 500,000 Israelis live in the West Bank and in Arab East Jerusalem, also captured by Israel in the 1967 war, alongside some three million Palestinians. The World Court considers the settlements illegal and Palestinians say the enclaves could deny them a viable state.

(Editing by Janet Lawrence)

Israel