Welcoming Palestinian president Mahmud Abbas to the White House on Wednesday, Obama promised the "full weight" of US diplomacy on the latest crisis and vowed to coax Israelis and Palestinians out of a "dead end" and into direct peace talks.
He also unveiled 400 million dollars of US aid for Gaza and the West Bank for housing, education and infrastructure, as part of a US commitment to improve the "day-to-day lives of Palestinians."
The president also called the humanitarian situation "unsustainable" and warned a Palestinian state was the only long-term solution.
The White House talks came with the Arab world still livid about the Israeli raid on the aid flotilla on May 31, which killed nine activists, and amid frantic US efforts to stop the uproar derailing peace efforts.
Telling Abbas he remained deeply committed to spending personal political capital in the Middle East, Obama said he still believes there could be "significant progress" in the peace process this year.
The US leader said it may be possible to take the "tragedy" over the Gaza aid convoy and turn it "into an opportunity to create a situation where lives in Gaza are actually, directly improved."
Abbas said that the aid package was "positive."
He told Obama in front of reporters the Palestinians were willing to proceed to direct talks with Israel, but only after progress in the current US-mediated "proximity" discussions.
The Palestinian leader urged the Obama administration to help implement a two-state solution "as quickly as possible."
"The two-state solution is no longer only a Palestinian interest or an Israeli interest or a Middle East interest, but it is also an American interest," he added on the televised "Charlie Rose" interview show.
As Obama seeks to inject new momentum into peace moves, both the White House and the Israeli government said they were trying to finalize arrangements for a visit to Washington by Israeli Prime Minister Benjamin Netanyahu this month.
The Israeli leader had been due here last week, to smooth over tensions that flared during his last visit, but the Gaza crisis forced him to cancel.
Chief Palestinian negotiator Saeb Erakat, who attended the Oval Office meeting, meanwhile said US envoy George Mitchell would go back to the Middle East next week for more proximity talks.
Erakat said Abbas had come to the United States with the message that progress was urgently needed.
"Time is of the essence, that's his message, we need to see genuine movement in the direction of a two-state solution and ending the occupation," he told AFP.
Obama also called on Israel to live up to UN Security Council conditions on probing the flotilla raid, which laid out the need for "credible, international involvement."
"I've said to the Israelis directly... it is in Israel's interest to make sure that everybody knows exactly how this happened so that we don't see these kinds of events occurring again," he added.
But Israel has rejected any international inquiry into the affair, amid calls for an easing of the three-year blockade of Gaza.
Earlier, Netanyahu said he was in talks with "several members of the international community" but added that a probe should not focus on the role of Israeli soldiers in the raid.
While stressing Israel had a right to make sure arms were not smuggled into Gaza, Obama said a framework should be hashed out to allow some non-arms shipments to reach the tiny Palestinian coastal enclave.
The White House said the aid package for Palestinians would help "increase access to clean drinking water, create jobs, build schools, expand the availability of affordable housing, and address critical health and infrastructure needs."
The money will be mostly funneled through the US Agency for International Development and the United Nations Relief Works Agency, which deals with Palestinian refugees.
The United States avoids dealing with Gaza's ruling Hamas, which it deems a terrorist organization, and has worked to shore up the West Bank government of Prime Minister Salam Fayyad.
Obama's pledge of aid for Gaza and the West Bank drew an angry response from Representative Ileana Ros-Lehtinen, the top Republican on the House Foreign Affairs Committee, who branded it a "bailout of the Palestinian leadership."
The help "sends the message that standing in the way of peace and freedom can be quite profitable," she said, calling for cutting off US government aid to the Palestinian Authority and the UN agency for Palestinian refugees.
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