By Jeffrey Heller

JERUSALEM (Reuters) - U.S. envoy George Mitchell said on Sunday he hoped to wrap up an agreement over the next few days in talks with Israeli and Palestinian leaders on a settlement freeze and a revival of peace negotiations.

"While we have not yet reached agreement on many outstanding issues, we are working hard to do so, and indeed the purpose of my visits here this week is to attempt to do so," Mitchell said with Israeli President Shimon Peres at his side.

Mitchell, who arrived in Israel on Saturday, has been trying to prepare a package under which Israel would freeze settlement construction in the occupied West Bank and Arab nations would take initial steps toward recognizing Israel.

Washington hopes both moves would lead to the resumption of Israeli-Palestinian peace talks suspended since December.

Mitchell meets Israeli Prime Minister Benjamin Netanyahu on Monday and holds talks the next day with Palestinian President Mahmoud Abbas, who has said he would not restart peace negotiations unless Israel committed to a settlement freeze.

"There is still work to be done," Netanyahu told reporters before flying to Cairo for talks with Egyptian President Hosni Mubarak. Progress has been made on some issues and there are certain things in which we have yet to make progress."

Netanyahu said he hoped he and Mitchell would be able to "narrow the gaps and perhaps to bridge them" in order to move forward in what he termed the "diplomatic process."

While Israeli officials have held out the prospect of a moratorium in new construction starts in settlements, Netanyahu has said the building of some 2,500 homes for Israelis in the West Bank would continue and that the city of Jerusalem would not be included in any settlement deal.

Peres met Mitchell only hours after being discharged from hospital, where he spent a night under observation after fainting during a public appearance.

U.N. MEETING

The United States hopes an agreement on the settlement issue would pave the way for a meeting involving Netanyahu, Abbas and U.S. President Barack Obama on the sidelines of the U.N. General Assembly around September 23.

But Palestinian chief negotiator Saeb Erekat said Abbas would tell Mitchell there would be no compromise.

"Israel must halt all settlement activities including natural growth," Erekat said.

Some 500,000 Israelis live in settlements in the West Bank, land which Israel captured in a 1967 war and Palestinians seek for a state, and Arab East Jerusalem, which Israel has annexed as part of its capital in a move not recognized internationally.

Palestinians, who number about three million in the West Bank, say settlements deprive them of land for a viable country and have called on Israel to meet its commitment, under a 2003 peace "road map" to freeze settlement activity.

Stoking Palestinian anger and drawing U.S. condemnation, Israeli Defense Minister Ehud Barak approved last Monday 455 building permits in settlements.

The move was widely seen in Israel as a bid to placate settlers before any freeze of construction starts. An Israeli government official said it was a step toward a "package" deal that could include "very severe limitations in the growth of settlements -- a possible moratorium."

(Additional reporting by Ori Lewish, Editing by Elizabeth Fullerton)