RAMAT GAN, Israel, (AFP/Reuters) - Israeli Prime Minister Benjamin Netanyahu on Sunday endorsed for the first time the creation of a Palestinian state after weeks of pressure from Washington, but said it must be demilitarised. A spokesman for Palestinian President Mahmoud Abbas dismissed the speech by Netanyahu as sabotaging peace efforts. The Hamas movement slammed Israeli Premiers remarks on the Middle East conflict, saying it reflected a racist, extremist ideology. In a keynote speech on the Middle East peace process at Bar-Ilan University in Ramat Gan, near Tel Aviv, Israeli Premier Netanyahu also said the Palestinians must recognise Israel as a Jewish state, a condition Palestinian President Mahmud Abbas has long rejected. He also said Jerusalem must remain united capital of Israel If we have the guarantees on demilitarisation and if the Palestinians recognise Israel as the state of the Jewish people, then we arrive at a solution based on a demilitarised Palestinian state alongside Israel, Netanyahu said. Each will have its flag, each will have its anthem, he said. The Palestinian territory will be without arms, will not control airspace, will not be able to have arms enter, without the possibility of striking alliances with Iran or (Lebanese Shia militia) Hezbollah. Netanyahu also ruled out a complete halt to settlement activity - which the Palestinians have said is a condition for relaunching negotiations. I do not wish to build new settlements or to confiscate lands to that end, but we have to allow the residents of the settlements to live normal lives, he said, using the stock phrase for allowing construction to accommodate population growth in settlements. The key condition is that the Palestinians recognise in a clear and public manner that Israel is the state of the Jewish people, Netanyahu said. The heart of the (Middle East) conflict has always been the Arabs refusal to accept the existence of the Jewish state, he said. The withdrawals that Israel has carried out in the past have not changed this reality. The Jewish Prime Minister said Palestinian refugees must not be resettled inside Israel. The refugee problem must be solved outside of Israeli borders, Netanyahu said. Their return goes against the principle of Israel as a Jewish state. Netanyahu said the leadership of the Palestinian Authority must defeat Hamas. They must decide between the way of peace and the way of Hamas, Netanyahu said. The Palestinian Authority must impose law and order ... and overcome Hamas. Israel will not negotiate with terrorists trying to destroy it. Slamming the speech by Netanyahu, Palestinian President Mahmoud Abbas spokesman Nabil Abu Rudeinah said, Netanyahus remarks have sabotaged all initiatives, paralysed all efforts being made and challenges the Palestinian, Arab and American positions. Noting Netanyahus demand that Jerusalem be the undivided capital of Israel and that Palestinian refugees not be allowed into Israel, he said, This will not lead to complete and just peace. His remarks are not enough and will not lead to a solution. It hobbles all efforts to save the peace process, in a clear defiance of the US administration, he said. This speech reflects the racist and extremist ideology of Netanyahu and denies all the rights of the Palestinian people, Hamas spokesman Fawzi Barhum told AFP. This speech is the reiteration of the policy of his government, which aims at transforming the Palestinian people into a tool to protect the occupation.