* Settlement freeze expires Sunday, peace talks threatened
* U.S. tries to resolve Israeli-Palestinian row
* Pro-settlers ready to resume building in West Bank
(Adds comments by Obama confidant)
By Jeffrey Heller
JERUSALEM, Sept 26 (Reuters) - Prime Minister Benjamin Netanyahu urged Israeli settlers to show restraint after a limited building freeze expires on Sunday, a plea that appeared aimed at persuading Palestinians not to quit peace talks.
Settler leaders vowed to begin erecting next week some 2,000 homes in the occupied West Bank, where Netanyahu in November imposed under U.S. pressure a 10-month moratorium on housing starts.
Celebrating the end of the partial freeze, set to expire at midnight (2200 GMT), settlers and members of Netanyahu's Likud party released balloons into the sky at a rally at the settlement of Revava in the occupied West Bank.
Palestinian President Mahmoud Abbas has threatened to quit the direct peace negotiations, launched in Washington on Sept. 2, unless the moratorium was extended.
Netanyahu, whose governing coalition is dominated by pro-settler parties, has resisted calls from U.S. President Barack Obama to do so.
But the Israeli leader has held out the prospect of limiting the scope of renewed construction, a message he seemed to underscore in an official statement.
"The prime minister calls on the residents in Judea and Samaria (the West Bank) and the political parties to show restraint and responsibility today and in the future exactly as they showed restraint and responsibility throughout the months of the freeze," it said.
A Palestinian official said there was no breakthrough in U.S. efforts to save the negotiations. David Axelrod, a close confidant of U.S. President Barack Obama, said the two sides were working with U.S. Secretary of State Hillary Clinton and other U.S. officials to reach a deal on the settlement issue.
"DUSTBIN OF HISTORY"
At Revava, the crowd cheered as hundreds of balloons drifted aloft.
"Tonight, we place this miserable decision back into the dustbin of history," Danny Danon, a Likud legislator told the crowd.
The United States held extensive discussions with Israeli and Palestinian officials over the weekend to try to resolve the crisis.
"They are talking. They're trying to work this through, and we're hopeful that they will," Axelrod said on the ABC News show "This Week with Christiane Amanpour", describing the discussions as serious.
Speaking by telephone from Paris, where Abbas was visiting, Nabil Abu Rdainah, a spokesman for the Palestinian leader, told Reuters: "The American efforts are continuing. So far, there is no breakthrough."
Israeli Defence Minister Ehud Barak said there was more than an even chance the peace process would continue.
"I think that the chance of achieving a mutually agreed understanding about (a) moratorium is 50-50," Barak said in a BBC interview in New York, where he met U.S. officials. "I think that the chances of having a peace process is much higher."
Abbas, whom Netanyahu has publicly urged to remain in the negotiations, also appeared to indicate the talks would not be suspended immediately upon the moratorium's expiration.
Asked in an interview with the pan-Arab newspaper al-Hayat, whether he would declare an end to the negotiations if the freeze did not continue, Abbas said: "No, we will go back to the Palestinian institutions, to the Arab follow-up committee."
He was referring in the interview, conducted on Friday and published on Sunday, to an Arab League forum that gave him the go-ahead to pursue direct peace talks with Israel.
Abu Rdainah said Abbas had requested a meeting of the follow-up committee in Cairo and it would likely convene "within days".
More than 430,000 Jews live in well over 100 settlements established across the West Bank and East Jerusalem on land that Israel captured from Jordan in a 1967 Middle East war.
The World Court deems settlements illegal, although Israel disputes this.
Palestinians say they will make it impossible for them to create a viable state and the issue is one of the core problems standing in the way of any peace deal.
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