He has been trying to encourage the two sides into peace talks.

Mr Bush said in a statement: "These negotiations must ensure that Israel has secure recognised and defensible borders and they must ensure the state of Palestine is viable, contiguous, sovereign and independent.

"It is vital that each side understands that satisfying the other's fundamental objectives is key to a successful agreement.

"Security for Israel and viability for a Palestinian state are in the mutual interests of both parties."

Two homelands

And he added: "Agreement must establish Palestine as a homeland for the Palestinian people just as Israel is a homeland for the Jewish people."

Mr Bush did not give details of precisely what a final agreement might contain - but his statement set out parameters within which he expected negotiators to work.

On Palestinian refugees - a key issue for Arabs since the creation of the state of Israel in 1948 - he said an international mechanism would need to be set up involving compensation.

His diplomatic language indicates that the hundreds of thousands of Palestinians in refugee camps around the Middle East should give up hopes of returning to their former homes in what is now Israel.

Instead, they could expect some kind of cash payment.

He also said a peace agreement would require mutually agreed adjustments to the pre-1967 boundaries "to reflect current realities" - a reference to Israeli settlements in the occupied West Bank.

And he called on Arab states to reach out to Israel - a step he said was "long overdue".

Mr Bush goes on to Gulf states on Friday, some of which have been less hostile to Israel than other Arab states.

Earlier, Mr Bush said he believed the two sides would be able to sign a peace deal before he leaves office in January 2009.