Palestinians and Israelis must try to improve living conditions in the West Bank and Gaza Strip to keep the peace process alive ahead of a visit by US President George W. Bush in May, Envoy for the Quartet of Middle East Peace Brokers, Tony Blair, said on Tuesday.

Blair also told the European Parliament that progress in the peace talks was crucial to build both sides' confidence in the negotiations and to show that Palestinians could take charge of security, and called for a new strategy on dealing with the Hamas -run Gaza Strip.

"We are approaching the crunch time for this stage of the process," said the former British prime minister.

"President Bush will go back to Israel at the beginning of May," he said. "I think it's got to be fairly clear by then that we are in a different and better position than we are today."

Blair said Palestinians and Israelis need to agree on establishing industrial parks, infrastructure projects and movement restrictions. Defense Minister Ehud Barak said on Monday that Israel will try to allow more movement within the West Bank, but is not ready to commit to removing checkpoints, saying they were needed for security.

"If we've learned anything from the past few months it is that the present strategy in Gaza is not working," Blair said. "We need a strategy that isolates the extremists and helps the people, and at the moment if we are not careful we've got the opposite, which is that we are isolating the people and helping the extremists, and that is not intelligent."

Blair said peace negotiations between the Palestinians and the Israelis needed "a significant change in the context, the realities on the ground, to get to fruition. It is possible to get this resolved but we need to be aware of the fact that we are racing against time," he said, referring to the talks that were re-launched in November.

France's Europe Minister Jean-Pierre Jouyet called for "concrete gestures" from Israel that were visible on the ground. "Without this we risk seeing the position of the moderates weakened and that of the extremists reinforced," he said, terming settlement building in the West Bank counter-productive.

He also endorsed a reconciliation deal reached in Yemen on Sunday between Hamas and Fatah headed by Palestinian President Mahmoud Abbas. The rival Palestinian organizations Fatah and Hamas promised to revive direct talks after months of hostilities, but differences remained over the future of the Gaza Strip and the West Bank.