US President George W. Bush speaks during a joint press conference with Palestinian President Mahmoud Abbas, 10 Jan 2008

President Bush says both Palestinians and Israelis have difficult choices and painful concessions to make if they are to reach a lasting peace agreement.

Speaking in Jerusalem Thursday, the U.S. president called on Israel to end its 40-year occupation of Palestinian territory. He urged the two sides to agree on border adjustments and said Palestinian refugees and their descendants should be compensated for the homes they left decades ago in what is now Israel.

Mr. Bush gave an outline of the two-state peace agreement he hopes will be reached this year - before he leaves office - after two days of separate talks with Israeli and Palestinian leaders.

Friday, the president will visit Israel's Yad Vashem Holocaust memorial and holy sites in the Galilee region before leaving for Kuwait to begin a round of visits to Arab capitals.

After Kuwait, the president's Middle East tour will take him to Bahrain, the United Arab Emirates, Saudi Arabia and Egypt.

Thursday, Mr. Bush met with Palestinian President Mahmoud Abbas in Ramallah, the West Bank headquarters of the Palestinian Authority, then visited Bethlehem, the town that Christians revere as the birthplace of Jesus.

Mr. Bush says he is confident that an Israeli-Palestinian peace treaty can be reached this year. President Abbas said he agrees that 2008 should be a year of peace, adding, "Peace in the world starts from here - from the Holy Land."

Israel captured the West Bank, East Jerusalem and the Gaza Strip in the 1967 Six-Day War. Mr. Bush said the future of Jerusalem, claimed by both Israelis and Palestinians as their capital, will be one of the most difficult challenges on the road to a peace agreement.

In his outline view of a future peace, Mr. Bush said Israel must have secure, recognized and defensible borders, and a Palestinian state must be viable, contiguous and sovereign.