The new US position drew an angry response from Palestinian militant group Hamas, which said armed resistance was the only way forward for Palestinians.
Mr Bush signalled the change as he endorsed a plan by Israeli Prime Minister Ariel Sharon to withdraw from the Gaza Strip and some West Bank settlements. The US President also said Palestinian refugees should not be allowed to return to land lost to Israel more than 50 years ago.
Palestinian Prime Minister Ahmed Qurie described Mr Bush’s move as unacceptable and in breach of the US-led Middle East peace process.
The President hailed Mr Sharon’s proposal as “historic and courageous”.
A senior Israeli official said the withdrawal would be completed in 2005.