(Reuters) - The European Union told Iran on Monday it must suspend uranium enrichment, a few days after the Islamic state ruled out doing just that, as Tehran and the West engaged in diplomatic shadow- boxing ahead of nuclear talks this month.

The United States called on Iran to take "urgent practical steps" to build confidence during negotiations with world powers on Tehran´s nuclear program, which Washington and its allies suspect is a bid to develop an atomic bomb capability.

Iran, attending an international conference in Vienna alongside its Western foes, for its part accused the United States of supporting Israel´s atomic activities. The Jewish state is widely assumed to hold the Middle East´s only nuclear arsenal.

Iran and the six major powers resumed discussions last month in Istanbul after a gap of more than a year - a chance to ease escalating tension and avert the threat of a new Middle East war - and both sides described the atmosphere as positive.

The next meeting between the powers - the United States, France, Britain, China, Russia and Germany - and Iran is to take place on May 23 in the Iraqi capital. Iranian officials say they are "optimistic" about making progress.

But with Iran seeking an end to sanctions and Western states reluctant to prematurely ease the pressure they credit with bringing Tehran to the negotiating table, diplomats are already playing down the chances of a settlement in Baghdad.

"A lot of people are talking the Baghdad talks up. We are also hopeful. But it is important to remain realistic," one European diplomat said. "This will be a start, not an end."

Western officials fear Iran may be hardening its demand for relief from sanctions which have been tightened over the past year to target its oil exports, and say this round of talks will at best serve as a stepping stone towards a final deal.

They want to see Iran take firm action to allay their concerns over its nuclear program and curb its processing of uranium before considering relaxing punitive steps on Tehran.

With an EU embargo on Iranian crude due to start in full on July 1, Tehran is likely to push hard on the sanctions issue.

But, a diplomat said: "I fear the Iranians misunderstand the nature of European decision-making. The embargo is a decision that´s already taken."

At the meeting in Vienna to discuss the 189-nation nuclear Non- Proliferation Treaty (NPT), U.S. envoy Robert Wood expressed concern over what he called "Iran´s persistent failure" to comply with its obligations under the pact.

"We seek a sustained process that produces concrete results, and call on Iran to take urgent practical steps to build confidence and lead to compliance with all its international obligations," Wood told delegates.

The West wants verifiable assurances from Tehran that it is not seeking to develop atomic arms - for example, by accepting much more intrusive U.N. inspections and limiting its enrichment capacity.

WEST SAYS IRAN STONEWALLING

Israel and the United States have not ruled out military action to prevent Iran from building nuclear weapons if diplomacy fails to resolve the long-running row.

Iran denies having a weapons agenda, saying it is enriching uranium solely for peaceful energy purposes, not for bombs.

Iran "is strongly committed to the objective of preventing proliferation of nuclear weapons under its NPT obligations," Iranian Ambassador Ali Asghar Soltanieh said in a speech.

Soltanieh told Reuters last week that Iran would "never" suspend enrichment, which can have both civilian and military purposes, and saw no reason to close the Fordow underground site which it has used to expand higher-grade nuclear activity.

The U.N. Security Council has demanded in a series of resolutions since 2006 that Iran suspend all enrichment.

Many analysts say a negotiated solution will require compromises on both sides: Iran would be allowed to continue some lower-level enrichment if it accepts much more intrusive U.N. nuclear inspections to make sure it has no weapons aims.

But the EU, which includes European heavyweights France, Germany and Britain, showed no sign of backing down on the suspension demand in its statement to the Vienna meeting.

"Iran must suspend its enrichment activities and heavy water related projects, including research and development," Gyorgyi Martin Zanathy, head of the EU delegation, said.

Daniel Keohane of FRIDE, a European think-tank, said the best outcome in Baghdad would be a "fleshing out of issues" that would be a part of a deal but the "danger is that the Iranian position can harden" in the meantime.

The week before the broader political negotiations take place in Baghdad, the U.N. nuclear agency and Iran will hold a new round of discussions in Vienna on May 14-15 after two meetings earlier this year failed to make any headway.

The International Atomic Energy Agency (IAEA) wants Iran to address questions raised in a report it issued last November detailing what it said were suspected Iranian research and development activities relevant to making nuclear weapons.

Iran has dismissed the allegations as fabricated.

Wood, the U.S. envoy to the U.N. agency, said: "We are concerned that Iran has not agreed to grant the IAEA access to all relevant sites, information, documents and persons necessary to resolve questions about its nuclear program." (Editing by Jon Hemming) (© Thomson Reuters 2012. 05/07/12)