Tony Blair and President Bush have called for an end to transatlantic divisions, backed moves for a Middle East peace deal and pledged to "finish the job" in Iraq.

Speaking after two days of talks in Washington, the British prime minister set out the steps required for successful final status negotiations between Israel and the Palestinians.

And he won the strongest endorsement yet from the American leader for the creation of a Palestinian state.

Bush said he would "do what it takes" and spend US political "capital" to achieve a deal

"I think it is fair to say that I believe we've got a great chance to establish a Palestinian state," Bush said.

"And I intend to use the next four years to spend the capital of the United States on such a state."

He added: "I believe it is in the interests of the world that a truly free state develops."

In his opening remarks, Blair said the two countries had "stood together since September 11, 2001 in order to combat this new form of global terrorism that we face."

He pointed to three key issues which had to be faced, including promoting democracy in Afghanistan, ensuring that the coalition will "complete our mission in Iraq" and "revitalising" the Middle East peace process.

On the Middle East, the prime minister said the two countries would mobilise international support to help the development of Palestinian institutions, and back Ariel Sharon's disengagement plan in the Gaza Strip.

That would lead to final status negotiations based on democracy and the rule of law. "I think there is every possibility that we can do this," said Blair.

President Bush backed that commitment, calling for a "just and peaceful resolution" to the Israeli-Palestinian conflict.

"The months ahead offer a new opportunity to make progress towards a lasting peace," he told journalists.

Speaking on the day of Yasser Arafat's funeral, Bush also said new Palestinian presidential elections could be the "first step" towards a final deal.

"We look forward to working with a Palestinian leadership that is committed to fighting terror and committed to the cause of democratic reform," he added.

Close relationship

During the White House media briefing, Bush praised his "friend" Blair as a man of "unshakeable convictions".

The president said the two nations had helped bring democracy to Afghanistan. "Together we are serving the same cause in Iraq," he added.

Bush welcomed the "substantial progress" in ridding Fallujah of terrorists.

"British, American and other coalition forces are helping to provide the stability that is necessary for free elections," he said.

"As those elections draw near the desperation of the killers will grow and the violence could escalate."

But the success of democracy would be a "crushing blow" to the terrorists, the president said.

"The United States and Great Britain... will continue to stand with our friends and we will finish the job."

The two leaders also called for the healing of transatlantic divisions brought into the open by disagreements over the Iraq war.

The president said the US and EU should retain their "close" relationship, and pledged to visit Europe soon after his inauguration.

"In my second term I will work to keep alive our transatlantic ties to the nations of Europe."

Blair defended his close ties to Bush as the right thing to do for Britain.

"We are not fighting this war on terror because we are an ally of the United States," he said.

"We are an ally of the United States because we believe in this war on terrorism."