The Palestinian leader, Mahmoud Abbas, has said he may remain in peace talks even if the Israelis resume construction in Jewish settlements in the occupied West Bank after a 10-month building moratorium expires.

His comments signal a dramatic about-turn days before the end of the moratorium, and could head off an early challenge to the newly revived peace negotiations.

Rioting in east Jerusalem, however, threatened to overshadow the peace process yesterday after an Israeli security guard, hired to protect Jewish settlers living at the heart of an Arab neighbourhood, shot dead a Palestinian man.

Israeli police dispersed stone-throwing Palestinians with tear gas, stun grenades and rubber bullets as violence spilled over into other parts of the city, marking the worst clashes in months. As thousands joined the funeral procession for the dead man, supporters called for a bloody revenge.

The hasty call to arms underscores the challenge faced by the Palestinian and Israeli leaders to smooth over the animosity that has kept alive the decades-old conflict.

The Palestinian leadership has threatened repeatedly to quit the fledgling peace talks if Israel resumes building in the West Bank. The Israeli Prime Minister, Benjamin Netanyahu, has refused to extend the 26 September deadline, despite international pressure to do so. But at a meeting with Jewish Americans in New York late on Tuesday, Mr Abbas signalled that he would back down from his earlier demands.

"I cannot say I will leave the negotiations, but it's very difficult for me to resume talks if Prime Minister Netanyahu declares that he will continue his activity in the West Bank and Jerusalem," Mr Abbas said.

Jerusalem has proved the most intractable issue, with some 180,000 Israelis now living in Arab-dominated east Jerusalem. Israel has claimed the city as its "indivisible" capital.

Yesterday, friends and neighbours silently lined the street outside the home of the dead Palestinian, Samer Serhan, as they awaited the arrival of his body. Clashes resumed during the funeral march, with Palestinians hurling stones at police and torching two cars. Police briefly took up positions in the holy al-Aqsa mosque compound, which adjoins the Western Wall.

Israeli police said the incident took place when Palestinians blocked a road in the Silwan district early yesterday, blocking the way of a private security guard in his vehicle. The Palestinians then hurled stones at the guard, prompting him to fire in the air, killing one.

The guard was taken in for questioning, and later released.

Residents expressed disbelief at the Israeli version of events, alleging that the guard pursued and shot Mr Serhan. His father-in-law, Said Abu Snad, whose wife was rushed to hospital after hearing the news, said that Mr Serhan had been shot twice in the stomach, throwing into question claims that shots were fired only in the air.

Residents have long complained that the positioning of armed guards, who protect the 70 or so Jewish families living in gated compounds in the area, are a constant source of friction in the area.

Tensions are especially high in Silwan over controversial plans by the authorities to raze scores of Palestinian homes to make way for a tourist park.