UPDATE 6-No talks until Israel halts settlements, PLO says

* U.S. backs two-state solution despite obstacles

* Palestinians to discuss next steps at Arab summit

* Netanyahu calls on Abbas to continue negotiating

* Palestinians aim to increase pressure on Israel - analyst

* Abbas spokesman sees "state of paralysis" for some time

(Adds U.S. envoy and Arab League head comments)

By Ali Sawafta

RAMALLAH, West Bank, Oct 3 (Reuters) - Direct talks with Israel will not resume unless it halts the building of Jewish settlements on occupied land, the Palestinian leadership said on Saturday.

U.S.-backed peace talks, launched a month ago in Washington, were plunged into crisis this week by the end of a 10-month Israeli moratorium on new settlement building in the West Bank. Israel has said it will not extend the freeze.

"The resumption of talks requires tangible steps, the first of them a freeze on settlements," Yasser Abed Rabbo, a senior Palestine Liberation Organisation (PLO) official, said after a meeting of the body's executive committee in Ramallah.

Israeli Prime Minister Benjamin Netanyahu and Palestinian President Mahmoud Abbas have held three rounds of face-to-face negotiations since Sept. 2.

"The Palestinian leadership holds Israel responsible for obstructing the negotiations," said Abed Rabbo. Abbas, head of the PLO, chaired the meeting.

U.S. envoy George Mitchell, who met Arab League head Amr Moussa and intelligence chief Omar Suleiman in Cairo on Saturday, said the United States remained committed to a two-state solution despite challenges.

"Peace in the region and an independent and viable state for the Palestinian people will be realistically achieved through direct negotiations," Mitchell told reporters.

"This is a difficult process ... We know there have been and will be many more obstacles, but we must work to overcome the challenges and we are doing so," he said.

Asked about possible options to resolve the impasse, Moussa said there were solutions but declined to elaborate ahead of an Arab League summit in Libya on Oct 8.

Netanyahu called on Abbas to continue negotiating.

"Just one month ago the Palestinians entered direct peace talks, without preconditions, after my government made a series of unilateral gestures to get the talks moving," Netanyahu said in a statement after the PLO decision.

"I hope now they will not turn their backs on peace and continue the talks in order to reach a framework agreement in a year," he said.

The end of the settlement freeze had been flagged as an early stumbling block facing U.S. President Barack Obama's attempt to reach a Middle East peace deal within a year. Israel imposed the freeze under U.S. pressure.

Abbas had said he would pull out of direct talks if Israel did not extend the freeze. The PLO statement said the Palestinians would discuss their next steps with the Arab League's peace process committee at the summit in Libya.

"The Palestinian calculation is that the Americans will continue their efforts to try to bring about a formula that may be acceptable to the Palestinian side," said George Giacaman, a political scientist at Birzeit University near Ramallah.

"I would not say that the process has ended. The American administration will continue pursuing the matter."

BIBLICAL PAST

Palestinians say the growth of the settlements, on land Israel has occupied since 1967, will render impossible the establishment of a Palestinian state in the West Bank and Gaza Strip, the stated goal of the peace talks.

About 500,000 Jews have settled on territory where the Palestinians hope to establish their state with East Jerusalem as its capital. To Israel, the West Bank is "Judea and Samaria", where the Jews trace their biblical past.

Netanyahu, whose coalition government is dominated by pro-settlement parties including his own Likud, has said he would not extend the moratorium that expired on Monday.

An official quoted Netanyahu on Friday as saying it had not been easy to freeze construction for the past 10 months and that he had lived up to his commitments to the Palestinians, the United States and the international community.

"Now I expect the Palestinians to show some flexibility," Netanyahu was quoted as saying. "Everyone knows that measured and restrained building in Judea and Samaria in the coming year will have no influence on the peace map."

Mitchell shuttled between Abbas and Netanyahu for two days this week. The two sides agreed to keep talking via Mitchell, the way they had communicated before beginning the direct talks. (Additional reporting by Marwa Awad in Cairo; writing by Tom Perry; editing by Tony Austin)