Israel will allow construction within built up areas of existing Jewish settlements in the occupied West Bank, but will not expand beyond those areas, Israeli officials said on Monday.

The position could widen the rift in U.S.-backed peace talks launched by Israeli Prime Minister Ehud Olmert and Palestinian President Mahmoud Abbas in Annapolis, Maryland last month.

The Palestinians say the negotiations, the first in seven years, hinged on Israel committing to halt all settlement activity, including so-called natural growth, as called for under a long-stalled "road map" peace plan.

The Bush administration has likewise urged Israel to stop settlement expansion.

A senior Israeli official said: "America doesn't have to approve or not to approve if we are doing something that we think, as a sovereign state, we should do."

While Israel's decision would allow construction within existing built-up areas, off limits would be the land that lies between existing buildings and the much larger outer jurisdictional boundaries of the settlements, officials said.

The first round of the peace talks following Annapolis opened in discord last week after the Palestinians demanded a halt to Israeli plans to build new homes at a settlement near Jerusalem known to Israelis as Har Homa and the Palestinians as Abu Ghneim.

Israeli construction at the same settlement derailed a previous round of talks in 1997.

The senior Israeli official, speaking on condition of anonymity, said the Har Homa development plan was approved 10 years ago by the Israeli government and called for 6,500 units, 4,500 of which are already being built and lived in.

"We said both to the Americans and to the Palestinians that in those places, within the built-up line, Israel will continue to build, because there is no other way," the official said.

The official said the fate of Har Homa and other building projects depended on the outcome of the negotiations, which Olmert and Abbas said they hoped to complete before Bush leaves office in January 2009.

"If Har Homa will not be part of Israel, it doesn't matter if Har Homa is 5,000 units or 6,000 units, Har Homa will be dismantled," the official said.

Israeli officials have sought to play down the rift over settlements, saying Abbas and Olmert were expected to meet as early as next week and that their negotiating teams would reconvene on Dec 23 or 24 ahead of a visit early next month by President George W. Bush.

In addition to requiring Israel to halt all settlement activity, the road map's first phase calls on the Palestinians to crack down on militants. Israeli officials have conditioned implementation of any peace deal on the Palestinians doing so in both the occupied West Bank and the Hamas-controlled Gaza Strip.

"Before Palestine will be established, Gaza will have to comply with the rules that are existing in the first phase of the road map," the senior Israeli official said.

The official said Israel defined a settlement freeze as a commitment not to build any new settlements and not to confiscate any additional Palestinian lands for settlement use.

Included in its definition of a settlement freeze, the official said Israel will not provide economic incentives for more Israelis to move to existing settlements.

"It doesn't mean people cannot go and live in existing settlements. Where there are vacant places, vacant apartments, people can go and live there with their families," he said.

"If somebody bought an empty lot in one of the settlements 10 years ago and he owns it, and he decides now in the year 2007, 10 or 15 years after he purchased it, to build on it, the government of Israel cannot do anything about it."

The official said it was unclear what "natural growth" included.