JERUSALEM, July 11 (Allyn Fisher-Ilan/Reuters) - A senior Palestinian figure said on Sunday that rising tension with Israel over settlement building in the Jerusalem area was a time bomb that was eroding trust between the two sides.

Ahmed Qurei, a former prime minister and negotiator, joined Tzipi Livni, a former Israeli foreign minister and now opposition leader in parliament, in calling on both sides to work harder to achieve a two-state solution.

The Jerusalem situation, I think, is a time bomb if it continues in this way, Qurei told a forum of mostly Israeli academics in Jerusalem, referring to the expansion of Jewish settlements in East Jerusalem and plans to demolish Palestinian homes to make way for more construction.

It has an impact on the Palestinian people ... and on trust on both sides, Qrei added.

Jerusalem is a core issue in the Israeli-Palestinian conflict. Israel has annexed East Jerusalem as part of its capital in a move not recognised internationally, and Palestinians want the area as capital of a future state in the West Bank and the Gaza Strip.

The conflict has erupted lately into weekly protests by Israelis and Palestinians, mostly in the predominantly Palestinian areas of Silwan and Sheikh Jarrah, where Jewish settlers have been moving in.

Israeli Prime Minister Benjamin Netanyahu, back from talks in Washington with President Barack Obama, said he might discuss Jerusalem but did not hint at any concessions.

We have differences of views with the Palestinians. We want a united city. They have their own views. We can -- this is one of the issues that will have to be negotiated, Netanyahu said on Fox News Sunday.

Though Netanyahu supports a two-state solution, and wants direct talks with Western-backed Palestinian President Mahmoud Abbas, pro-settler parties in his government have made it hard for him to yield enough ground on core issues.

Abbas, for his part, insists on making more progress before indirect talks launched in May are upgraded.

Qurei, an ally of Abbas's Fateh movement and an architect of a 1993 interim deal with Israel negotiated in the Norwegian capital, was bitter at the slow pace of diplomacy since then.

It is 19 years since Oslo, and things remain as is, he said.

Livni, head of Israel's centrist Kadima party that lost an election last year to Netanyahu's right-wing Likud, called the current period a crucial point in time.

Iranian-backed Islamist groups that reject Israel's existence are gaining ground, and Israel should seize the chance to make peace with Palestinian moderates, Livni said.

Agreeing to Palestinian statehood in the West Bank, which Israel captured in the 1967 Middle East war, is in Israel's interest, and not a gift to the president of the United States, she added. The status quo is not possible. (Editing by Tim Pearce)