JERUSALEM - Israeli Prime Minister Benjamin Netanyahu has accepted the creation of a Palestinian state for the first time, in a move welcomed abroad, but observers warned on Monday that the conditions he set effectively killed any chances of a peace deal.

After months of pressure from main ally the United States, the premier broke with his right-wing Likud party's ideology and endorsed the two-state solution, the cornerstone of international Middle East peacemaking efforts for years.

But he set a slew of conditions -- Palestinian recognition of Israel as a state of the Jewish people, their state will have to be demilitarised, have no control of its air space, no ability to forge military pacts and Israel must have ironclad security guarantees.

"Then we will be ready in a future peace agreement to reach a solution where a demilitarised Palestinian state exists alongside the Jewish state," Netanyahu said in a speech laying out peace policies of his 11-week-old government.

While Washington and Europe welcomed the address as an "important" step forward, the Palestinians said it aimed to sabotage peace efforts and observers in Israel said it amounted to empty rhetoric, with the news website Ynet describing it as "the same old babble" aimed at pleasing the United States.

"A pain killer to stop international pressure, but at this stage there will be no movement on the ground," said Ayoob Kara, an MP with Netanyahu's Likud.

Ron Pundak, a political analyst, said: "He finally said the words Palestinian state, but with conditions that are unacceptable to the Palestinians."

The Palestinians have long rejected one of the premier's main demands that they recognise Israel as a homeland of the Jewish people, as that would mean them effectively giving up on the right of return, a cherished dream among the 4.6 million Palestinian refugees scattered around the Middle East.

The Palestinians also slammed Netanyahu for not heeding the US call to halt all settlement activity, something they have demanded in order to relaunch negotiations that the two sides revived at a US conference in November 2007 but that were suspended during the Gaza war earlier this year.

"He spoke of a Palestinian state while emptying it of any substance by excluding a stop to settlements," Yasser Abed Rabbo, a senior aide to Palestinian president Mahmud Abbas, told AFP right after the speech.

And Abbas's spokesman Nabil Abu Rudeina said that the address "torpedoes all peace initiatives in the region" and "hobbles all efforts to save the peace process."

Local observers said that while agreeing to a Palestinian state may have been difficult for the leader of the right-wing Likud party -- one daily said he "vomited the words" -- the move was mostly aimed at pleasing Israel's main ally.

"Sometime in the future we will engage in negotiations with the Palestinians without pre-conditions, as long as they agree to our pre-conditions. Later we’ll see what comes out of it," is how Ynet qualified the 30-minute address.

The mass-selling Yediot Aharonot said "Netanyahu's speech was meant for one pair of ears... the ears of (US President) Barack Obama."

Obama's administration has vowed vigorously to pursue the hobbled Middle East peace process as part of a changed approach to the region, and has repeatedly called on Israel to stop settlements and accept a Palestinian state.

The blunt talk from its main ally has raised fears inside the Jewish state that Washington may ease its support as it tries to improve its relations with the Muslim world.

The White House welcomed Netanyahu's speech as an "important step forward," while the European Union said it was "a step in the right direction."

On the domestic side, Netanyahu drew criticism both from within his hawkish coalition, where many felt he went too far, and from the left which considered he didn't go far enough.

"The prime minister caved in to American pressure. He will have to explain to his coalition why he was ready to go so far," Likud MP Danny Danon told AFP.

Ilan Gil-On of the left-wing Meretz party countered with "the prime minister proved again that he is the number one peace refusenik."