DAVOS, Switzerland (Reuters) - Palestinian leaders warned their Israeli counterparts on Friday that a new spirit of cooperation between the Middle East foes would endure only if Israel´s Gaza pullout was linked to a final peace settlement.

Leaders from both sides addressing the World Economic Forum hailed the new mood of goodwill since the January 9 election of Palestinian President Mahmoud Abbas after more than four years of bitter armed conflict.

"A window of opportunity, a dramatic change is shaping up and taking place," Israeli Deputy Prime Minister Ehud Olmert, a close ally of Prime Minister Ariel Sharon, told world business and political leaders.

Sharon´s decision to withdraw unilaterally from the Gaza Strip and remove Jewish settlements there this year, and the emergence of a new democratic Palestinian leader had created the opportunity, he said.

Sharon has said conditions were right for a "historic breakthrough" on Middle East peace and if Palestinians worked to "fight terror" then Israel could move forward with a U.S.-backed peace "road map" meant to lead to a Palestinian state.

But Palestinian Liberation Organisation official Yasser Abed Rabbo said in Davos the dream of a new partnership could be destroyed if Israel continued expanding West Bank settlements and building its security barrier on expropriated Arab land.

"With what is currently going on on the ground, building the wall around the Palestinian populated areas and the expansion of the settlements, I´m afraid my dream will be lost," he said.

NOT SUB-CONTRACTORS

"We cannot be sub-contractors for unilateral Israeli moves," Abed Rabbo said of Sharon´s plan to pull out of Gaza over the summer, handing authority to Palestinians.

"We need a comprehensive solution that will close all the gaps ... Side by side with the Gaza step, there should be a resumption of the final status negotiations."

Israeli Vice Prime Minister Shimon Peres, whose more dovish Labour Party this month joined a national unity government with Sharon´s right-wing Likud, said he was surprised and impressed by Abbas´ rapid implementation of security measures in Gaza.

"This is the first time someone has taken on leadership and in a few days changed the entire atmosphere," Peres said of Abbas. "All of a sudden there is a meeting of minds and moods."

The Palestinian leader has persuaded militant groups to observe a de facto truce and deployed Palestinian security forces to stop rocket attacks on Israel.

But Israeli Foreign Minister Silvan Shalom told the WEF the Palestinians must do more to dismantle the infrastructure of armed groups, otherwise fresh attacks could undermine any progress towards peace.

Olmert offered to start immediate talks with the Palestinians on handing over control of the Erez industrial zone on the Israel-Gaza border, which he said could be the nucleus of an independent Gaza economy.

But Palestinian Finance Minister Salam Fayyad cautioned: "Important though it is, economic development is no substitute for a credible, durable progress on the political track."

WEF founder Klaus Schwab called for the forum, which has met for the last 35 years in the Swiss ski resort of Davos except for one session in 2002 in New York, to hold a future meeting in the West Bank town of Bethlehem, biblical birthplace of Jesus to show support for a two- state solution.

He presented the leaders with mementoes of mountain crystal on plates inscribed: "World Economic Forum, Bethlehem - date to be announced soon." (© Reuters 2005 01/28/05)