It may well be a “discussion among friends”, in the words of George Mitchell, the US envoy to the Middle East, but Israel’s continued settlement building in occupied territory is shaping up to be a crucial issue that will test the leaderships of all players involved in the Palestinian-Israeli conflict.

Reports in the Israeli media suggest that Israel and the US are close to a deal on settlement construction that would see Israel continue building some 2,500 housing units already under way, as well as some non-residential building, in return for enacting a complete freeze on all other settlement construction for an unspecified amount of time and dismantling 23 settlement outposts.

Such a deal would represent a compromise that might see hopes for renewed peace negotiations between Palestinians and Israelis dashed. It would certainly put Mahmoud Abbas, the Palestinian Authority president, in a very difficult position, after having publicly rejected the idea of relaunching negotiations while settlement construction continued.

It would also be a blow to the credibility of Barack Obama, the US president, who has staked a fair amount of prestige on his ability to deliver at least a settlement construction freeze in his efforts to seek a negotiated end to the conflict as well as improved general Arab-Israeli ties. Finally, if properly enforced, a settlement construction freeze of any kind will not play well with Israel’s influential settler lobby, which could put the coalition of Benjamin Netanyahu, the Israeli prime minister, partly made up of members of this lobby, under strain.

In other words, the horse-trading that is replacing principled positions, necessary say some, is forcing a political position that none of the parties may end up being happy with.

“This is the nature of politics,” said Yossi Alpher, an Israeli analyst. “I am not surprised at reports of some sort of compromise that it will still be hard for Netanyahu to deliver his coalition to. I think he can, however, and I imagine the US could tell Abbas that they didn’t deliver 100 per cent but they delivered 90 per cent.”

However, Mr Abbas has repeatedly said he would not sanction negotiations with Israel unless there was a total freeze on Israeli settlement construction. It would be hard for him to persuade an already sceptical public that negotiating with the current Israeli right-wing coalition while some settlement building continues constitutes any kind of advance.

“Palestinians have to realise that they are left alone in their confrontation with Israel, its Judaisation of Jerusalem, and that they are losing their land and the future,” said Mahdi Abdul Hadi, head of the Palestinian Academic Society for the Study of International Affairs.

Mr Abdel Hadi said he thought Mr Abbas’s concerns did not figure highly on Washington’s agenda and did not expect any bilateral negotiations process to be launched in the near future. Washington, he said, was not particularly interested in such a process, but was instead more focused on ensuring some Arab normalisation measures with Israel and in preventing any potential Israeli strike on Iran.

Mr Mitchell has visited Damascus, Tel Aviv and Cairo in the past two days on a regional tour that is meant to put some impetus into Arab-Israeli peacemaking but is also addressing the regional situation as a whole.

Yesterday, and after swinging by Tel Aviv, Mr Mitchell went to Egypt, where it is likely that he was sounding out Hosni Mubarak, the Egyptian president, on the Arab response should the US strike a deal with Israel over a settlement construction freeze.

In the first such reaction, Amr Musa, the Arab League chief, rejected any kind of improved Arab-Israeli relations for as long as settlement construction continued.

“There will be no Arab steps before Israel stops its policy of settlement building,” he said yesterday in Cairo.

It remains to be seen if Arab countries will maintain such a stance and make an Israeli settlement construction freeze a prerequisite for movement on regional peace making. It does appear that Arab countries are in a stronger position to make this demand than the Palestinians, who remain divided and have little diplomatic leverage.

Back in Jerusalem yesterday, Mr Mitchell told reporters after meeting Shimon Peres, the Israeli president, that, “in an effort to overcome a focus on the past, we call for steps by Arab states to do what they can to fulfil the promise of an Arab peace initiative.”

But if Mr Musa’s comments are representative, the ball will be back in Washington’s court, where, for now, the US appears to have stepped back from being willing to exercise anything other than verbal pressure on Israel, pressure that is proving not to be enough.

“Israel’s settlement policy is so deeply rooted in Israeli society that in order to change it, much more severe pressure needs to be exercised on the Israeli government,” said Dror Etkes, a settlement expert with the Israeli human rights group Yesh Din.

“We are not close to that kind of pressure yet. I am not dismissing the current American pressure, but it’s still far, far away from being enough.”