Prime Minister Ariel Sharon accepted today Israel would have to give up some occupied land for peace with Palestinians.
However, he vowed to speed up work on a disputed West Bank barrier it deems vital to its security.
He also raised the possibility, in a question and answer session with Israeli editors, that he would take unspecified "unilateral steps" should talks with the Palestinians on advancing a US-backed peace "road map" fail.
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Mr Sharon: accelerating the fence
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Mr Sharon's comments hardened hints floated in local media that he was prepared in the event of continued stalemate in the peace process to remove some isolated Jewish settlements and draw the boundaries of a Palestinian state along the route of the barrier, which cuts deep into the West Bank.
"It is clear that in the end we will not be in all the places where we are now," the right-wing premier said. "(But) we are accelerating the fence and we won't stop it because it is essential to the security of the state."
Washington said on Tuesday it was penalising Israel for the barrier and settlement expansion by deducting nearly $290 million from a multi-billion-dollar package of loan guarantees.
Mr Sharon faces growing calls at home as well as abroad for bold action to end three years of violence and bolster the status of Palestinian moderates against militants by reining in settlers and lifting blockades imposed on Palestinian cities.
But opposition doves who have drafted an alternative, more far-reaching peace plan have dismissed Mr Sharon's signs of flexibility as insincere.
Palestinians say the barrier, a swathe of concrete walls, electric fences and razor wire, is a bid to annex terrain. "There is no viable Palestinian state if Israel continues to build the wall," Palestinian Prime Minister Ahmed Qurie said in the West Bank city of Ramallah after Mr Sharon's remarks.
US President George W. Bush last week called on Israel to stop the construction to avoid prejudicing future negotiations.