Israel's 10-month freeze on new housing starts in West Bank settlements expires at the end of this month and is a key point of contention in newly launched peace talks with the Palestinians. Palestinian President Mahmoud Abbas has threatened repeatedly to quit the talks if Israel does not renew the restrictions.
Netanyahu told Mideast envoy Tony Blair, "the Palestinians demand that after September 26, there will be zero building" in the West Bank.
"That will not happen," Netanyahu said on Sunday. Israel will not build "tens of thousands of housing units that are in the pipeline, but we will not freeze the lives of the residents."
The prime minister imposed a 10-month settlement slowdown in the West Bank to promote the resumption of peace talks. But several thousand housing units already being built were allowed to continue, and the measure does not apply to Jewish neighbourhoods in east Jerusalem. Even so, there has been a de facto halt to new construction there as well.
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Palestinians repeated their threats to leave the talks after Netanyahu's announcement.
"Our position is very clear," said spokesman Husam Zomlot. "Should the settlement construction and expansion continue, we are out."
Negotiator Nabil Shaath rejected one possible scenario - that Israel would halt construction in outlying settlements but allow building in settlement blocks closer to the Israel-West Bank line. Shaath said this would appear to give Israel the right to decide which settlements it will keep.
Palestinians want a state in the West Bank, Gaza Strip and east Jerusalem. They have expressed willingness to trade West Bank territory with Israel in exchange for Israeli land to allow some settlements to remain within Israeli borders after a peace deal, but no detailed agreement has been reached.
Netanyahu also told Blair the Palestinians must recognise Israel as a Jewish state, but he would not make that a condition for continuing the negotiations.
"I'm not saying that if this doesn't happen, I will get up and leave the peace talks," he said.
He also questioned the Palestinian stand on settlement construction, saying "it is not logical for the Palestinians to set a precondition and threaten to abandon the talks."
Speaking at the weekly meeting of his Cabinet earlier on Sunday, Netanyahu said that Israel recognises the principle of two states for two peoples, the Israelis and the Palestinians, but the Palestinians speak only of two states. "I hear them saying 'two states' but I do not hear them recognising two states for two peoples," he said.
Palestinian leaders have refused to recognise Israel as the state of the Jewish people because some 20 per cent of its citizens are Arabs, and the Palestinians claim the right of refugees and their descendants from the 1948-49 war that followed Israel's creation - several million people in total - to return to their homes in Israel.
Israelis firmly reject that as an attempt to undermine the Jewish character of their state.
