German Chancellor Angela Merkel demanded on Thursday that Israeli settlement building in the West Bank stop, saying it endangered efforts to achieve a two-state solution with the Palestinians.

"I think it is now important to get commitments from all sides and that includes the issue of settlement building," Merkel said in a speech to the Bundestag lower house of parliament.

"I am convinced that there must be a stop to this. Otherwise we will not come to the two-state solution that is urgently needed."

Merkel's remarks are in line with the positions of the EU and the US, but were unusually clear-cut for the German leader, who regularly cites her country's special obligation to Israel because of the Nazi Holocaust, in which six million Jews perished.

Palestinian President Mahmoud Abbas has said US-backed peace talks with Israel cannot resume until all settlement activity has ceased on occupied land the Palestinians want for a state.

Washington has also called for a total halt to settlement building in the West Bank, a demand that has opened the most serious rift in US-Israeli relations in a decade.

Israeli Defence Minister Ehud Barak said on Wednesday that Israel would consider a limited moratorium on new settlement construction, but said it should be part of a broader deal bringing Arab states into the peace process.

'Send strong message to Iran'

In her speech, Merkel also addressed Iran, saying she wanted next week's G8 summit to send a strong signal to the Islamic Republic, but also stressed it was important to keep open the possibility of talks on its nuclear program.

Group of Eight (G8) leaders will meet in L'Aquila, Italy on July 8-10, a month after hardline President Mahmoud Ahmadinejad was re-elected in a vote the opposition has denounced as a fraud. Tehran has cracked down on protesters, jailing many and accusing the West of fomenting unrest.

"I hope the meeting sends a strong message of unity, a united message that the right to demonstrate and human rights cannot be separated and that they apply to Iran," Merkel said.

"I strongly support President (Barack) Obama's offer to Iran of direct talks. We will accompany this in a united way. We cannot drop the issue of a nuclear-armed Iran just because of the current situation. That would be completely wrong."

The West accuses Iran of using a nuclear research program as a cover for developing nuclear weapons. Iran denies the accusation and says the work is intended for peaceful generation of electrical energy.

"The leadership in Iran must know that if they choose a path of reason, then we want Iran to develop prosperously," Merkel said.

"But if this is not the case, we will not shy away from stating our opinions and showing solidarity with those, including members of the British embassy, that have been put under pressure."