The French president took what Palestinian officials said were "courageous" positions when he advised the Israelis that the settlement activities, including those in East Jerusalem, would not bring peace or security to the Jewish state.

In a speech to the Israeli Knesset (parliament) on Monday, Sarkozy said: "There can be no peace without stopping settlements."

While he also stressed that the Palestinians needed to do more to "combat terrorism" in order to achieve peace, he nevertheless nudged the Israelis on the status of Jerusalem.

"There can be no peace without recognizing Jerusalem as the capital of two states and the guarantee of freedom of access to the holy places for all religions," Sarkozy told the Knesset, dominated by lawmakers who insist that the holy city should remain Israel's "united and eternal capital."

The Palestinians are seeking East Jerusalem, which Israel occupied in 1967 and later annexed in a move unrecognized by the international community, as the capital of their future state in a negotiated settlement.

On Tuesday in Bethlehem, Sarkozy widened smiles on the faces of Palestinian leaders when he went further and said the Israeli separation barrier – which also surrounds the town where Jesus was born, as well as much of the West Bank – would not guarantee Israeli security or provide justice for the Palestinians.

"I told our Israeli friends that injustice done to the Jewish people can't be resolved by creating conditions of injustice for the Palestinian people," the visiting president said at a joint news conference with Palestinian President Mahmoud Abbas.

Sarkozy, accompanied by his model-turned-singer wife, Carla Bruni, on the three-day visit to Israel and stopover in the West Bank town, stressed that France's priority for "the creation of a viable, democratic, modern state for the Palestinians" alone could bring peace and security for both peoples and end the decades-old conflict.

The French president, whom Abbas repeatedly described as a "friend" of the Palestinians, mentioned that "it was a pleasure to come here to Bethlehem to see what the checkpoints were like, the wall, the misunderstandings on either side. This must stop."

Israel has set up hundreds of roadblocks and checkpoints across the West Bank, citing security measures to prevent attacks by Palestinian militant groups and making the daily lives of Palestinians very difficult. It has also cited security as the justification for the 700-kilometer barrier Israel is erecting on seized Palestinian lands where the future state is to be established.

Sarkozy insisted that while Israel's security is "non-negotiable for France," he promised his Palestinian hosts that his country, the next one to assume the rotating presidency of the European Union, "will work toward the creation of your state. We will use the same strength, the same commitment we used in ensuring Israel's security."

For the Palestinians, the French leader's position sharply contrasted with the U.S. administration's stance widely seen as one that is more committed to Israel's own demands and plans at the expense of Palestinian aspirations for statehood.

Sources close to the Palestinian Authority (PA) said that Sarkozy's visit and his "balanced support" are accelerating Palestinian efforts to activate a European political role in the U.S.-sponsored peace negotiations with the Israelis.

Little progress has been made in the final status negotiations since U.S. President George W. Bush re-launched their peace process in Annapolis last November, raising serious doubts on the ability to reach the aspired goal of finalizing a deal before Bush's term expires in January.

Palestinian officials say they hope to see the EU, through French leadership, shift from an economic role to a political one to push for a peace deal that could last.

Sarkozy, however, said that only the Palestinians and Israelis can arrive at peace, but that his country was willing to help.

The president and Abbas had earlier in the day signed an agreement to establish a 21-million-euro industrial zone in the Bethlehem area, funded by France, as part of Europe's economic support for the Palestinians.

Sarkozy took the opportunity to lash out at Hamas, which controls the Gaza Strip, describing it as a terrorist organization that the West cannot deal with unless it first meets the international Quartet's conditions to recognize Israel and renounce violence.

"Violence cannot solve the problems," Sarkozy said. "Hamas is very wrong to have acted the way it did. You do not create peace through terrorism. We do not hold discussions with terrorists, only with people of peace, not people who lay bombs."

Hamas violently ousted Abbas' Fatah-led PA from Gaza a year ago, a move that has virtually split the Strip from the West Bank, where a different administration was created.

Meanwhile, in Berlin where a donors' conference was held to pledge $242 million for Palestinian security infrastructure, Arab League Secretary-General Amr Moussa told U.S. Secretary of State Condoleezza Rice and other top Western diplomats attending the forum to "lift the veto" off a Fatah-Hamas reconciliation.

The Arabs, led by Egypt, are brokering a reconciliation dialogue between the rival Palestinian factions, but the West, especially Washington, has been accused of obstructing a reconciliation that could legitimize Hamas – which had swept the January 2006 Palestinian legislative elections.

The international peace Quartet, in Berlin, was expected later Tuesday to reiterate its position that it would not speak to Islamist Hamas or remove the blockade on Gaza until it meets its conditions.