Barack Obama seems to have failed dismally in his first sustained attempt to show he is serious about making peace between Israel and the Palestinians. Obituaries for the hope generated by his election, peaking in his Cairo speech in June, are being written in Arabic, Hebrew, and English. For those who never believed that even Obama could succeed where Bill Clinton failed in the final days of his presidency, this was a death foretold.

But having been unable to persuade or cajole Binyamin Netanyahu to accept a total freeze on West Bank settlements, friendly Arab states to "normalise" relations with Israel or the Palestinians to restart long-stalled peace talks without preconditions, what will he do next?

Mahmoud Abbas's decision to stand down as Palestinian president has sharpened concerns that the moribund peace process is now facing a terminal crisis. Even if Abbas relents, as he yet may, Obama's strategy is clearly in deep trouble.

The US president's options can be roughly divided between raising or lowering the level of American ambition for tackling the world's most intractable conflict.

Raising it means tabling a big idea, a fully fledged peace plan or setting out parameters for a settlement. That would involve addressing the highly sensitive core issues such as final borders, the status of Jerusalem and the refugee question. The obvious danger is that a bold move could crash in flames, risking failure and damaging Washington's credibility.

Analysts and diplomats surveying prospects at an international conference in Warsaw this week agreed that Obama is more likely to lower his ambition – proposing interim or limited steps to be discussed when the parties return to negotiations. Possibilities include a further Israeli handover of part of the West Bank or adding a new set of mutual obligations to George Bush's 2003 road map.

Israel might accept such an approach: Shaul Mofaz, a former Likud defence minister, has suggested setting up a Palestinian state on 60% of the West Bank – circumventing all the knottiest problems. Overall, Netanyahu's government (the most rightwing in Israel's history) seems content to "manage" rather than resolve the conflict while seeking to further develop the West Bank economy – the agenda being pursued by Tony Blair, the quartet envoy.

But Palestinians would reject moves that do not end the total Israeli control over their disconnected enclaves. And any borders agreed on a "temporary" basis could turn out to last for years. Bitter experience suggests that Jewish settlements would meanwhile continue to grow.

Palestinians face a paralysing double division: within the West Bank, where Abbas's position has been badly weakened by his failure to deliver on peace with Israel; and between Fatah and the Islamists of Hamas in the Gaza Strip, where Yasser Arafat's successor is painted as no better than a collaborator with the occupation – presiding over a "Vichy" regime in Ramallah.

Obama needs to choose between attempting to resolve the conflict in all its aspects – a so-called "comprehensive peace" involving a deal with Syria and Israeli relations with Saudi Arabia and its Gulf allies – and opting again for piecemeal measures that may build confidence and add up to something more substantial over time. The model for that is the ill-fated Oslo process, which began with such high hopes in 1993 and ended in the second intifada seven years later – and with twice as many Israelis settlers on the ground.

Talking of Oslo, Obama is due in the Norwegian capital next month to accept the Nobel peace prize he was awarded so prematurely. The association of the venue with past failure means it may not a good idea to launch a new initiative on that occasion. Still, deciding what to do is far more difficult than choosing where to say it.

If most elements of this picture are grimly familiar, what has changed in recent days is the sense of deepening gloom captured in a report, on the dilemmas facing Fatah, by the International Crisis Group. "A peace process that yields results seems a distant prospect at best," it concludes. "The gap between the two sides, the character of Israel's government, entrenched divisions among the Palestinians and a US diplomacy that appears more captive than master of events – these and more have deflated the hopes of an Israeli-Palestinian breakthrough to which Obama's election had given rise." It is hard to fault the accuracy of that assessment.