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Israel and the United States are closing the gaps over the contentious issue of West Bank settlement construction, senior American officials who are intimately involved in the matter told Haaretz on Tuesday.

The Obama administration has demanded that Israel halt all construction in settlements in the West Bank, the swath of land that the Palestinians claim for a future state.

Prime Minister Benjamin Netanyahu has resisted U.S. and international calls for a total freeze on construction, arguing that the Bush administration had acquiesced to continued Israeli settlement activity in large blocs that are likely to be annexed by Israel in any future agreement with the Palestinians.

"We stated right from the outset what we want regarding the settlements, and we are getting close to getting this from Israel," a U.S. official said.

Netanyahu will meet Wednesday morning with U.S. special envoy George Mitchell in a bid to reach an understanding on the issue.

The meeting is expected to last at least three hours, yet aides to both men cautioned that another meeting may be necessary to tie up any loose ends before the UN General Assembly opens in New York in September. Mitchell is due in Israel for talks with officials in mid-September.

Netanyahu said on Monday that Israel and the United States are nearing a compromise that would allow for the resumption of peace talks with the Palestinians as well as "normal life" for Jewish settlers in the West Bank.

During a joint press conference with British Prime Minister Gordon Brown at 10 Downing Street in London, Netanyahu also held firm on his stance that Israel will not limit Jewish construction in East Jerusalem.

The settlers need kindergartens and homes for their families, the Israeli premier said, adding that this does not mean that this would necessitate expropriating more land in the West Bank.

"Jerusalem is not a settlement, and Israel will not accept limits on its sovereignty there," Netanyahu said.

Netanyahu said that progress in the Middle East peace process would "confound cynics and surprise the world."

The prime minister said he had outlined what he called the "winning formula" for Middle East peace.

"We need a demilitarized Palestinian state that recognizes Israel," Netanyahu told reporters after the one-hour meeting. "Recognition is the pillar of peace."

Brown reiterated his government's position that continued construction in settlements poses an obstacle to a two-state solution to the Israeli-Palestinian conflict, though he added that there appears to be progress on the issue.

The British prime minister said a freeze on settlement construction is likely to pave the way for normalization gestures by Arab states toward Israel.

Netanyahu says Israel had taken steps in easing Palestinian movement in the West Bank by lifting roadblocks and showed its willingness to make peace by expressing support for a Palestinian state. The Israeli leader said it was now incumbent on the Palestinians to demonstrate "courageous leadership."

"We hope to move forward in the next months and weeks," said the Israeli leader.

"With the help of our friends in the U.S., Britain and elsewhere we can achieve progress that will confound the cynics and surprise the world," he added.

He urged the Palestinian leadership to move forward in a "courageous" way and tell their people: "It's over, there is going to be real, final peace."

On the vexed issue of Israeli settlements, Netanyahu said he hoped to find a "bridging formula" that would enable residents already living there to lead a "normal life."

Netanyahu added that he was disappointed by statements made by Fatah officials during the party conference in Bethlehem earlier this month. Fatah, the premier said, should have adopted an unequivocal position that it was ready for an end to the conflict with Israel and an end to all claims.

On the issue of Iran's drive for nuclear weapons, Brown said the UN should consider tightening sanctions in the event Tehran refuses to engage in dialogue.

"If there is no further progress immediately then I believe the world will have to look at stepping up sanctions against Iran as a matter of priority," Brown said.

Asked about the prospect of Iran developing nuclear arms, Netanyahu said: "Time is running out, it is late in the day, but it is not too late."

Iranian officials have repeatedly refused to curb the nuclear program despite the threat of sanctions.

The International Atomic Energy Agency is due to release a report on Iran this week which is likely to strongly influence the international response.

Relations between Britain and Iran worsened after Iran's June presidential election. Brown accused Iran of "repression and brutality" in crushing protests against the re-election of hardline President Mahmoud Ahmadinejad.

Iran's Supreme Leader Ayatollah Ali Khamenei has called Britain "the most treacherous" of Iran's enemies.