JERUSALEM (Reuters) - Israeli Prime Minister Benjamin Netanyahu voiced regret on Sunday for the announcement of a Jewish settlement plan that has strained ties with Washington and threatens the revival of Middle East peace talks.

Israel's Prime Minister Benjamin Netanyahu attends the weekly cabinet meeting at his office in Jerusalem March 14, 2010. REUTERS/Jim Hollander/Pool

In his first public remarks on what Israeli commentators called his most serious crisis with Washington since taking office a year ago, he gave no sign he would meet Palestinian demands to cancel a project for 1,600 new settler homes.

“I suggest not to get carried away and to calm down,” Netanyahu told his cabinet, after a reprimand by U.S. Secretary of State Hillary Clinton and written statements issued by the prime minister’s office that failed to calm the dispute.

“There was a regrettable incident here, that occurred innocently,” Netanyahu said, referring to an announcement by a government ministry during a visit last week by Vice President Joe Biden, of planned construction in an area of the West Bank that Israel has annexed to Jerusalem.

The timing of the disclosure, after Palestinians agreed to indirect peace talks, embarrassed Biden and raised questions over whether Israel’s settlement policy could harm U.S.-Israeli security cooperation on the question of Iran.

“It was hurtful and certainly it should not have happened,” Netanyahu said of the announcement by the Interior Ministry, controlled by the religious Shas party, a member of a governing coalition dominated by pro-settler parties, including his own.

David Axelrod, a senior aide to President Barack Obama, told NBC’s “Meet the Press” program that Netanyahu’s comments in response to U.S. criticism showed “the message was received.”

A senior U.S. official forecast “a dicey period here in the next couple days to a couple of weeks” as Palestinians demanded reversal of the settlement plan.

A U.S. envoy is due back in the region later in the week to try to get peace talks suspended since December 2008 under way. Palestinian President Mahmoud Abbas had resisted restarting negotiations without a total Israeli settlement freeze.

An Abbas aide, Nabil Abu Rdainah, said Netanyahu’s comments fell short of what was needed for the talks to begin.

“What is required is the annulment of the Israeli decision and no return to the policy of provoking the Palestinian side,” Abu Rdainah said.

INSULT

In unusually blunt remarks, Clinton had called Israel’s behavior “insulting” after it approved the project while hosting Biden, who had focused during his visit on Washington’s commitment to Israeli security and sanctions against Iran.

Although Clinton stressed Washington’s ties with Israel were “durable and strong,” she told Netanyahu in a telephone call on Friday he must act to repair the relationship.

Netanyahu said at the cabinet meeting he had appointed a team of senior officials to look into the process leading up to the settlement project announcement and “to ensure procedures will be in place to prevent these kinds of incidents.”

It was not immediately clear whether the inquiry would help smooth relations with Washington after the latest display of friction between Netanyahu and Obama.

“In flames,” read the front-page headline in Maariv, a mass circulation, mainstream Israeli newspaper, underneath a cartoon depicting Obama boiling Netanyahu in a cooking pot.

Writing in the left-leaning Haaretz newspaper, commentator Aluf Benn said Netanyahu has reached “the moment of truth.”

He said Netanyahu must choose between political cooperation with the right and his need for U.S. support in curbing Iran’s nuclear program the West says is aimed a producing nuclear weapons, an allegation Iran denies.

Angering settlers and their supporters, Netanyahu announced in November a 10-month moratorium on new housing starts in West Bank settlements -- but exempted Jerusalem from the order. Washington praised the move.

Palestinians fear settlements on land Israel captured in the 1967 Middle East war will deny them a viable state in the West Bank and Gaza Strip, with East Jerusalem as its capital.

Israel considers all of Jerusalem its capital, a claim that is not recognized internationally.