RAMALLAH, West Bank - Palestinians voiced dismay on Monday over terms Benjamin Netanyahu set for a peace deal but the Israeli leader won guarded approval in Washington and Brussels for at least accepting Palestinian statehood.

In a speech on Sunday, Netanyahu responded to weeks of U.S. pressure by endorsing for the first time establishment of a Palestinian state, on condition Israel received international guarantees in advance the new nation would be demilitarised.

But Palestinians were disappointed by the prime minister's demand they recognise Israel as a Jewish state and his failure to halt Jewish settlement expansion in the occupied West Bank.

Salam Fayyad, prime minister in the Western-backed government of Palestinian President Mahmoud Abbas, said Netanyahu's speech dealt a new blow to efforts to salvage the peace process, and has undermined the possibility of resuming negotiations based on its terms of reference.

Netanyahu failed to meet the expectations of the international community and did not commit to obligations outlined in a 2003 U.S.-sponsored road map for peace, he said.

White House spokesman Robert Gibbs termed Sunday's address a big step forward for implementing President Barack Obama's peace vision.

The president believes that there's a long way to go and many twists and turns in the road to get there, but is pleased thus far with the progress that's being made, and I think yesterday's speech certainly is a big part of that.

The European Union described the speech as a step in the right direction but said it was not enough to raise EU-Israel ties to a higher level.

The Foreign Ministry of Russia, member of the quartet of peace negotiators, noted with satisfaction Netanyahu's adherence to the establishment of peace in the Middle East and his readiness to restart the negotiations immediately.

However, Egyptian President Hosni Mubarak said in remarks to troops that the call to recognise Israel as a Jewish state increases the complexity of the matter and aborts the chance for peace.

Palestinians argue that granting such recognition would effectively rule out any return of Palestinian refugees to what is now Israel.

DIFFERENCES

Interviewed on U.S. television on Monday, Netanyahu said he hoped to narrow differences with Obama over settlements.

Obama has called for a full settlement freeze, in line with the road map, but Netanyahu wants building to continue in existing West Bank enclaves.

President Obama and I are trying to reach a common understanding on this, Netanyahu said on U.S. television. I think we'll find some common ground.

Netanyahu pledged to keep all of Jerusalem as Israel's capital -- defying Palestinians' claim on the city -- and hedged on whether Israel would ever remove West Bank settlements.

He ruled out the admission of Palestinian refugees to Israel proper and said Abbas must impose his authority over the breakaway Hamas Islamists ruling the Gaza Strip.

An Arab League spokesman described Netanyahu's proposal as an attempt to embarrass Arab states by presenting them with impossible conditions.

He proposed this project so that the Palestinians and Arabs would reject it, as well as the international community, the spokesman was quoted as saying by Egypt's state news agency.

Palestinian negotiator Saeb Erekat said mediators should challenge Netanyahu on whether he was prepared to tackle territorial issues such as borders, Jerusalem and settlements.

Netanyahu is talking about negotiations about cantons -- the canton of the state of Palestine, with a flag and an anthem, a state without borders, without sovereignty, without a capital, Erekat said.

Netanyahu's speech met circumspection across the political spectrum in Israel, which has seen almost two decades of stop-start talks about a two-state solution, a concept the right-wing Likud party chief had long balked at endorsing.

Several Likud legislators accused Netanyahu of violating party policy, but a full-scale rebellion appeared unlikely and Likud cabinet ministers did not break ranks.

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