In an apparent indication of the type of compromise on the settlement-construction moratorium that Prime Minister Binyamin Netanyahu has in mind, he told Quartet envoy Tony Blair on Sunday that Israel would neither stop all construction in the West Bank after the moratorium ends on September 26, nor build all the tens of thousands of housing units that are in various planning phases.

“The Palestinians want that after the 26th of September there will be no building in Judea and Samaria, and that will not happen,” the prime minister said.

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“Israel cannot continue the moratorium,” Netanyahu said.

“On one hand, we will not build all the tens of thousands of housing units that are waiting in the planning pipelines, but on the other hand, we will not freeze life for the residents of Judea and Samaria and will not freeze construction.”

He said that Israel would build as the Olmert and Sharon governments built, meaning between 1,500 and 2,000 units a year. In this way Netanyahu is hoping to “square the circle,” telling the Palestinians that the current situation will continue, since building continued on about 2,500 units that were started before the moratorium went into effect in November, while telling his coalition partners, who want to see building continue, that the moratorium has ended.

Diplomatic sources said it was not clear, a day before the second round of direct negotiations on Tuesday in Sharm e- Sheikh, whether this formula would satisfy either the Palestinians or the Americans.

Palestinian Authority negotiator Nabil Sha’ath rejected one possible scenario – that Israel would halt construction in outlying settlements but allow building in settlement blocs closer to the Green Line.

Sha’ath said this would appear to give Israel the right to decide which settlements it will keep.

US President Barack Obama said last week he told Netanyahu during their talks in Washington that “it makes sense to extend that moratorium so long as the talks are moving in a constructive way.”

He also said he called on PA President Mahmoud Abbas to show the Israeli public that he is “serious and constructive in these talks so that the politics for Prime Minister Netanyahu – if he were to extend the settlements moratorium – would be a little bit easier.”

Netanyahu told Blair that he is not making recognition by the PA of Israel as the nationstate of the Jewish people a precondition for negotiations, and is not saying that if the Palestinians do not accept this condition, that Israel would walk away from the negotiations.

“In the same vein, it is not logical that the Palestinians now place preconditions and threaten to abandon the talks. That is not the way to seriously progress towards a peace agreement,” the prime minister said.

The Palestinians have said repeatedly since the talks were relaunched earlier this month that they would bolt the negotiations if the moratorium was not extended.

Netanyahu addressed the delicate political issue of the moratorium at a meeting with Likud ministers on Sunday, signaling that a compromise was possible.

He said the situation does not have to be “everything or nothing,” but that a middle ground also exists.

“It is impossible to accept a dictate not to build, but it is necessary to think what is the smart thing to do,” Netanyahu said. “Not renewing the moratorium will be viewed in the world as a serious test of Israel’s willingness to make progress in the diplomatic process.”

Netanyahu said there were 19,000 housing units in Judea and Samaria in the planning process, and that it was clear that there was no need to advance them all now.

Rather, he said, the building should be renewed according to natural growth, as previous governments did. He said there would not be a renewal of a moratorium based on orders from the defense minister, as was done when the current moratorium was declared.

In the weekly cabinet meeting that followed Netanyahu’s session with his Likud ministers, he did not talk about the settlement freeze, but rather about the need for the Palestinians to recognize Israel as the nation-state of the Jewish people, an issue he is increasingly putting on the scale opposite the Palestinian demand for a settlement moratorium.

Netanyahu, who repeated that he felt it was possible to reach a “framework that will be a basis for a peace settlement” within a year, said that the agreement needed to be based first of all “on the recognition of Israel as the national state of the Jewish people.

“The conflict between us and the Palestinians, as opposed to other conflicts that were resolved by peace agreements, is over the same piece of ground. We say that the solution is two states for two peoples, meaning two national states, a Jewish national state and a Palestinian national state,” he said.

“To my regret, I have yet to hear from the Palestinians the phrase ‘two states for two peoples.’ I hear them saying ‘two states,’ but I do not hear them recognizing two states for two peoples.”

This recognition was necessary if there was to be a true peace agreement that would end claims against Israel and put an end to the conflict between the two peoples, Netanyahu said.

Foreign Minister Avigdor Lieberman is scheduled to meet with US Secretary of State Hillary Clinton in Jerusalem on Wednesday. Clinton, along with US Mideast envoy George Mitchell, will participate in Tuesday’s talks in Sharm, and then will fly to Jerusalem on Wednesday, where the direct Israeli-Palestinian talks are scheduled to continue.

Lieberman has been a vocal critic of the process, and Clinton’s request to meet with him was viewed as an effort to temper his opposition.

Lieberman was originally scheduled to fly to Washington this week to participate in a conference, and also to meet with US Vice President Joe Biden and National Security Adviser James Jones. Because of the Clinton visit, that trip has been canceled.

Instead, Lieberman is expected to fly to New York at the end of the month and represent Israel at the UN General Assembly. This will be the first time that Lieberman will take part in the General Assembly meeting. Netanyahu addressed the gathering last year.

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