JERUSALEM, Dec 7 (Reuters) - The United States on Tuesday abandoned its effort to persuade Israel to freeze construction of Jewish settlements, officials said, dealing a blow to efforts to revive Israeli-Palestinian peace talks.

U.S. President Barack Obama brokered the direct talks that were relaunched in September but broke down over the issue of settlements built on captured land that Palestinians seek for a state.

We reached the conclusion this is not the time to renew direct negotiation by renewing the moratorium, a senior U.S. diplomat told reporters in Israel, ending weeks of intense U.S. diplomacy aimed at forging a settlement deal.

Palestinians have said they would not engage in any direct talks while Israelis build on territory seized in the 1967 Middle East War.

The decision marked a significant foreign policy setback for Obama, who had appealed personally to Israel to extend its temporary construction freeze.

Obama, in launching the talks in September, said he hoped to have a peace deal signed in a year, but the lack of a settlement agreement and the collapse of direct talks appeared to put that timeline in doubt.

In Washington, officials said the United States was weighing a return to indirect talks following its failure to revive the direct negotiations.

Two officials, who spoke on condition of anonymity, gave three reasons why the Obama administration decided to abandon the effort.

They said that while Israel was willing to extend the moratorium, it was not willing to freeze construction in East Jerusalem, something Palestinian officials had demanded as they want that part of the city as capital of their state.

(Extending) the moratorium did not close the gap between the two parties, said one U.S. official.

Second, the officials said that unless they made sufficient progress during a temporary Israeli extension of the moratorium they could end up in the same place in three months -- still struggling to keep the peace process alive.

We had to be prepared to think that substantial progress could be made in 90 days, said the same U.S. official, suggesting there was enough uncertainty about this that it did not seem worth proceeding.

Finally, they said that there were some concerns about the size of the incentives the United States offered Israel -- which Israeli sources said included 20 F-35 stealth fighters worth $3 billion -- for only a temporary extension.

'NOT THROWING IN THE TOWEL'

The officials said one possibility they would explore with senior Israeli and Palestinian officials who are expected to visit Washington -- possibly within the next week -- would be resuming indirect peace talks.

In the coming days and weeks we will engage both sides on the core substantive issues at stake in this conflict, a U.S. official said.

We're not throwing in the towel at all. Our objective is still a framework agreement ... (but) we are going to look for a different mechanism, the official said.

Israeli officials had no immediate comment, while a spokesman for Palestinian President Mahmoud Abbas said he was studying the U.S. decision..

The president received a letter from the American administration. The president will respond to the letter after he consults with the Palestinian leadership and the Arab leaders, Abbas spokesman Nabil Abu Rdainah said.

Senior members of Prime Minister Benjamin Netanyahu's pro-settler ruling coalition had criticised the demands for a settlement moratorium as tantamount to setting preconditions for peace talks and urged him to reject any U.S. offer.

Abbas suggested in a television interview on Friday he may seek to dissolve the Palestinian government, a limited form of self-rule agreed in an interim deal in 1993, if a deal for statehood could not be achieved.

Palestinian officials have said they may seek to declare statehood unilaterally in the occupied West Bank if negotiations with Israel foundered.

Three Latin American nations -- Argentina, Brazil and Uruguay -- declared recognition of a Palestinian state at the weekend, drawing Israeli condemnation. (Additional reporting by Dan Williams in Jerusalem, Mohammed Assadi in Ramallah and Arshad Mohammed in Washington; writing by Allyn Fisher-Ilan; editing by Angus MacSwan and Mohammad Zargham)