The Israeli Foreign Minister, Shimon Peres, has unveiled details of a peace plan he has been working on with the Palestinian parliament speaker, Ahmed Qureia.
Mr Peres's plan has three stages - first a ceasefire, then mutual recognition between Israel and a Palestinian state and finally agreement on the borders of the new state.
He said he envisaged negotiations on the terms of Palestinian statehood to take a year, and implementation a further 12 months.
"We will recognise a Palestinian state, they will recognise the state of Israel," Mr Peres told Israel Radio.
He said that at first, the state would include territory already under full or partial control of the Palestinian Authority - about two-thirds of the Gaza Strip and 40% of the West Bank.
The plan has not yet been approved by the Labor Party, but Mr Peres says he is confident his party will back him.
According to the agreement, Palestinian militant groups like Hamas and Islamic Jihad, which reject any peace deal with Israel, would be disbanded.