The official explained to Bibi Netanyahu that if there was a peace settlement, extra investment would push Israel's long-term growth rate from 5% a year to 7%. The Israeli prime minister responded that if the country had 5% growth, it did not need peace.

Netanyahu was joking, according to the official who recounted the story – but the quip highlights a serious point. There is no prospect of a settlement between Israelis and Palestinians, and many Israelis are fairly relaxed about that. During a recent visit to Israel, I met very few people who were optimistic about the peace process.

Netanyahu says he supports the creation of a Palestinian state. But the terms he is offering – with much of the hypothetical state's security under Israeli control – would not be acceptable to any Palestinian leader. Netanyahu's coalition government shows no signs of offering the Palestinians the kinds of concession – such as freezing settlements – that would make a peace deal possible.

Nor do the Palestinians seem ready for peace: recent attempts to bring both Fatah and Hamas into a national unity government came to nothing. Whether Mahmoud Abbas, the president of the Palestinian Authority, will carry out his recent threat to resign is unclear.

Within Israel, there is very little pressure for a peace settlement. Israelis are getting on with their lives, without – for now – the threat of suicide bombers. There are virtually no rocket attacks from the areas controlled by Hamas and Hezbollah. The barrier that snakes through the West Bank makes Israelis feel safer – and also less interested in what happens on the other side.

As for the Gaza strip, most Israelis do not want to think or talk about it. The only people I met who seemed worried about the situation there were foreign journalists, plus a few Israeli liberals – and Tony Blair, who as a peace envoy keeps telling the Israelis that the people of Gaza need to be "given a way forward". If pressed, moderate Israelis admit to being uncomfortable that their government (like Egypt) will not allow exports out of Gaza or building supplies in (on the grounds that Hamas would profit from any trade).

In Gaza, 40% of adults are unemployed and most of the rest are in government jobs. The West Bank is doing better, with only 20% unemployment and economic growth likely to be 7% this year – partly because Tony Blair and others have persuaded Israel to lift some of the restrictions on movement. Israelis hope that when Gazans see the brightening prospects of the West Bank they will turn against Hamas. In fact Hamas's popularity has waned to some degree since the last Israel-Hamas war, according to people who spend time in Gaza.

Can international pressure kick-start the peace process? Earlier this autumn Barack Obama pushed Netanyahu to accept a freeze on expanding West Bank settlements, but failed. Liberal Israelis say Obama made the mistake of demanding that the freeze should apply to the suburbs of East Jerusalem, which most Israelis do not regard as settlements. Netanyahu's successful resistance to US pressure has made him more popular. Many Israelis view Obama as both hostile and weak; his approval rating is below 10%.

Could the EU, Israel's top trading partner, and the biggest provider of aid to the Palestinian Authority, put pressure on Israel? It was planning to offer an "enhanced agreement" that would establish regular EU-Israel summits, and give Israel the right to take part in a range of EU programmes. But earlier this year the EU said it would hold up the agreement until Israel did more to alleviate the plight of Gaza. This conditionality, which annoys Israel's leaders, might be more effective if the EU increased its offer. Why not tell the Israelis that if they forge a peace deal with the Palestinians, they could join the European Economic Area, giving Israel – like Norway and Iceland – full access to the EU's single market?

But for now, the Europeans' divisions over how to handle Israel weaken their credibility as a partner for it. For example earlier this month, when the UN General Assembly debated the Goldstone report – which had accused Israel of war crimes in Gaza – the EU split three ways: the Czech Republic, Germany, Italy and the Netherlands were among those voting with the US to reject the report, Britain and France led a large group of member-states into abstention, and a few others, including Ireland, Portugal and Cyprus, voted for the report.

Many Israeli politicians and businessmen have a dark view of Europe. At a conference I attended in Jerusalem, one minister – a noted dove within the Israeli government – complained about the influence of Muslim minorities on the foreign policies of EU countries. I told him that Germany and the Netherlands, two states with large and vocal Muslim minorities, were among Israel's best friends in Europe. He countered that the Czech Republic and Poland, which had very few Muslims, did not criticise Israel. And he claimed there was a direct correlation between the willingness of British MPs to criticise Israel, and the size of the Muslim minority in their constituencies.

Several Israelis at the conference complained that, having sprung from European civilisation, they were now among its last defenders, given that the high birth rate of Muslim immigrants and Islamist ideology were undermining that civilisation from within (I have heard very similar comments in Serbia and Russia).

Reinforcing the Israelis' gloomy world-view is their fear of Iran's nuclear programme. Many of them urge the West to understand that the real problem in the Middle East is not the question of Palestine but the extremist alliance of Iran, Syria, Hizbollah and Hamas that threatens Israel and moderate Arab regimes.

Israelis have long been worried about Iran. But their fear of Turkey – until very recently a close ally – is new. The Turkish government's criticism of Israeli actions in Gaza and its recent cancellation of joint military exercises makes Israelis fret that Turkey is nestling up to the Iran-led coalition. They worry about the growing power of Islamists in Turkey, the diminishing role of the secular army in Turkish public life, and Prime Minister Erdogan's burgeoning friendship with Iran's President Ahmedi-Nejad. Erdogan's recent comments to the Guardian about the validity of the Iranian presidential election process were unfortunate. But I think many Israelis exaggerate Turkey's eastward tilt. Erdogan is trying to balance Turkey's foreign policy between the EU, the US, Russia, Iran and the Arab world, and that may be in Turkey's best interests.

However, a lot of Israelis seem to believe the worst of Turkey, as they do of many countries. Many of the Israelis that I met see themselves as increasingly isolated in a hostile world.