RAMALLAH, West Bank (Reuters) - Palestinians voiced dismay on Monday over terms Benjamin Netanyahu set for a peace deal but the Israeli leader won guarded approval in Washington and Brussels for at least accepting Palestinian statehood.

In a speech on Sunday, Netanyahu responded to weeks of U.S. pressure by endorsing for the first time establishment of a Palestinian state, on condition Israel received international guarantees in advance that the new nation would be demilitarized.

Palestinians were disappointed by Netanyahu’s demand that they recognize Israel as a Jewish state and his failure to halt Jewish settlement expansion in the occupied West Bank.

Salam Fayyad, prime minister in the Western-backed government of Palestinian President Mahmoud Abbas, said Netanyahu’s speech “dealt a new blow to efforts to salvage the peace process, and has undermined the possibility of resuming negotiations based on its terms of reference.”

Netanyahu “failed to meet the expectations of the international community” and did not commit to obligations outlined in a 2003 U.S.-sponsored “road map” for peace, he said.

But U.S. President Barack Obama said he saw “positive movement” in Netanyahu’s speech and again urged Israel to halt settlement construction.

“Both sides are going to have to move in some politically difficult ways in order to achieve what is going to be in the long-term interests of the Israelis and the Palestinians and the international community,” Obama said. “On the Israeli side, that means a cessation of settlements.”

The European Union described the speech as “a step in the right direction” but said it was not enough to raise EU-Israel ties to a higher level.

The Foreign Ministry of Russia, a member of the quartet of peace negotiators, noted “with satisfaction” Netanyahu’s “adherence to the establishment of peace in the Middle East” and “his readiness to restart the negotiations immediately.”

However, Egyptian President Hosni Mubarak said in remarks to troops that the call to recognize Israel as a Jewish state “increases the complexity of the matter and aborts the chance for peace.”

Palestinians argue that granting such recognition would effectively rule out any return of Palestinian refugees to what is now Israel.

DIFFERENCES

Interviewed on U.S. television, Netanyahu said he hoped to narrow differences with Obama over settlements.

Slideshow ( 9 images )

Obama has called for a full settlement freeze, in line with the road map, but Netanyahu wants building to continue in existing West Bank enclaves.

“President Obama and I are trying to reach a common understanding on this,” Netanyahu told NBC television. “I think we’ll find some common ground.”

He pledged to keep all of Jerusalem as Israel’s capital -- defying Palestinians’ claim on the city -- and hedged on whether Israel would ever remove West Bank settlements.

Slideshow ( 9 images )

He also ruled out the admission of Palestinian refugees to Israel proper and said Abbas must impose his authority over the breakaway Hamas Islamists ruling the Gaza Strip.

An Arab League spokesman described Netanyahu’s proposal as an attempt to embarrass Arab states by presenting them with impossible conditions. “He proposed this project so that the Palestinians and Arabs would reject it, as well as the international community,” the spokesman was quoted as saying by Egypt’s state news agency.

Palestinian negotiator Saeb Erekat said mediators should challenge Netanyahu on whether he was prepared to tackle territorial issues such as borders, Jerusalem and settlements.

“Netanyahu is talking about negotiations about cantons -- the canton of the state of Palestine, with a flag and an anthem, a state without borders, without sovereignty, without a capital,” Erekat said.

Netanyahu’s speech met circumspection across the political spectrum in Israel, which has seen almost two decades of stop-start talks about a “two-state solution,” a concept the right-wing Likud party chief had long balked at endorsing.