A day after President Barack Obama told Israel its key ally would no longer tolerate building settlements in the West Bank, the European Union was considering using its trade clout to bolster U.S. pressure, diplomats said.

The EU is the Jewish state's biggest trading partner and one option it may have is to crack down on fruit, vegetables, olive oil and other farm produce grown by Israeli settlers on occupied Palestinian land.

Some European governments have long suspected such products are entering the EU at low import tariffs reserved for output labeled as coming from Israel proper.

It was the latest sign of the depth of the dispute between Prime Minister Benjamin Netanyahu's government and its closest allies.

In Washington, Secretary of State Hillary Clinton hit back hard at comments by a senior Israeli negotiator who said Obama's predecessor George W. Bush privately agreed to expansion of settlements. That was not U.S. policy, she insisted.

At the same time, there was no sign of a change of heart by Netanyahu's two-month-old government, a coalition that includes right-wing groups attached to expanding the colonization of the West Bank.

That leaves Israel and the powers that have been its principle sponsors more deeply at odds than in many years.

"The Israelis are listening," one European diplomat said.

"But there is no sign that the Israelis have any intention of stopping. So what next?"

A senior Israeli diplomat said Israel was still trying to figure out how seriously to take the threats: "The question in our minds is: How much staying power does Obama have?"

Obama's landmark address to the Muslim and Arab world in Cairo on Thursday dominated Israeli media.

Much attention was paid to his declaration that all further settlement building was not "legitimate" in American eyes and his call for a Palestinian state -- both elements that Netanyahu has not wished to accept.

So U.S. and EU diplomats are discussing "pressure points" that could be used to persuade the prime minister, who risks seeing his coalition break down if he makes concessions. Envoys may meet on Wednesday to coordinate a response, diplomats said.

EU-ISRAEL TRADE

Aside from the possibility of a concerted push to deny tariff concessions to settlement produce coming into the European Union, diplomats said EU nations also were looking at using economic and scientific research exchanges with Israel as an area where they could apply leverage on Netanyahu.

In addition to being Israel's largest market for exports, the EU is its second largest source of imports after the United States.

But diplomats said Europe would follow Washington's lead. Concerted EU action will be difficult because of divisions within the bloc so piecemeal steps are more likely, they added.

Israeli President Shimon Peres, a former left-of-center prime minister, sought to play down differences with Obama. "I think, basically, we accept his vision," he said.

Other Israeli officials said Netanyahu had no intention of freezing all settlement activity but would try to ease friction by removing roadblocks that make travel difficult for Palestinians and by removing small Jewish outposts that are not authorized by the government.

Even Netanyahu's opponents baulked at Obama's call for a full settlement freeze: "This is an illegitimate demand," said leading lawmaker Tzahi Hanegbi of the centrist Kadima party.

Obama's envoy, George Mitchell, will visit Israel and the West Bank starting on Monday. Western and Israeli officials said the White House was formulating a blueprint for a renewed peace process that could be presented to the parties early next month.

Near term, diplomats said, the Quartet of Middle East mediators -- the United States, the EU, Russia and the United Nations -- was considering stepping up public censure of Israel over settlements and home demolitions in Arab East Jerusalem.

Washington could also refrain from acting at the United Nations to thwart resolutions critical of Israel, and scale back Israel's access to American decision-making.

If the dispute drags on, Washington could withhold the bulk of what remains of loan guarantees for Israel, but a Western official said of that option: "It's a long way off."