Israel is willing to hand over Arab east Jerusalem to the Palestinians as part of a new peace initiative, the Deputy Prime Minister said yesterday.

The announcement came amid reports that the two sides were considering handing custody of the Old City’s holiest site to Jordan. Haim Ramon, the Israeli Deputy Prime Minister, said that handing over parts of the predominantly Arab east Jerusalem could be on the table during a regional conference to be held in the United States next month.

“I agree that all the Palestinian neighbourhoods, except the Arab neighbourhoods in the holy basin, would be transferred,” Mr Ramon said. His statement met with a positive response from an extreme-right leader in the coalition Government.

The Israeli Right has opposed transferring parts of Jerusalem, which both sides consider to be their capital. “We must make concessions on the Jerusalem issue, or transfer to Palestinian control some of the neighbourhoods and refugee camps,” said Avigdor Lieberman, of the Yisrael Beiteinu party.

However, the comments were condemned by others on the Right. “Jerusalem is not on the negotiations agenda,” said Eli Yishai, the Trade and Industry Minister.

“The issue of the division of Jerusalem is an inalienable asset of the state of Israel. Palestinian refugees will not be returned to Israel and Jerusalem will not be divided,” Shaul Mofaz, the Transport Minister, added.

Mr Ramon said that he hoped a special administration could be set up to manage the disputed holy centre of the Old City, the site of the destroyed Jewish temple and the Dome of the Rock and al-Aqsa Mosque.

A London-based Palestinian newspaper, al-Quds al-Arabi, said that Mr Olmert had agreed during recent talks with Mahmoud Abbas, the Palestinian President, that Jordan could be given custodianship of the huge plaza that dominates the Old City.

An Israeli Foreign Ministry spokesman said that under the 1994 Israeli-Jordanian peace accord, Amman was granted extensive rights in the upkeep of the historical site. “That is a commitment that Israel abides by,” he said.

Both sides were wary of disclosing details before the talks next month in Annapolis, Maryland. Israeli and Palestinian negotiators were meeting yesterday to draft a joint document to be issued at the conference.