By Avida Landau

JERUSALEM, June 5 (Reuters) - Palestinians expressed sadness while Israelis voiced pride on Tuesday on the 40th anniversary of the start of a brief war that changed all their lives.

In Jerusalem's Old City, seized by Israel in what would be called the Six Day War, there was the usual bustle. Jews and Arabs ran errands and foreign tourists sought out bazaar bargains and sites sacred to Judaism, Islam and Christianity.

"Today life is normal. But the sadness is inside every person," said a 51-year-old Palestinian stall holder, who gave his name as Samir. "This is a bad day because we're still seeking our freedom."

Palestinians remember June 5 for the "naksa", or setback, of Israel's lightning 1967 victory over Arab armies that followed the "nakba" -- disaster -- of Israel's founding in 1948, when many were driven from or fled their lands, becoming refugees.

But a few streets away in the walled city's Jewish quarter, a shopkeeper said Palestinians should accept the situation.

"We should show the world that this is a unique day for Israel," said jewellery store owner Perla Daisey Filiba, 51.

"The Arabs across the alley should accept us being here and they should know that Israel is the land of the Jewish people ... and Jerusalem is our capital."

SACRED SITE

Israel controlled the city's western suburbs from 1948 but Jordanian troops on the eastern side of the "Green Line" established by a ceasefire in fighting that year gave Jews little access to their most sacred site, the Western Wall.

"I feel very proud today because now the Western Wall belongs to the Jewish people," said Filiba.

Many Muslims say their access to the al-Aqsa Mosque in the Old City is limited by Israeli troops whose presence in East Jerusalem is not recognised as legal by the United Nations.

Israel defeated Arab armies led by Egypt, Jordan and Syria in the Six Day War.

At the Beach refugee camp in the Gaza Strip, Abu Mohammed, 58, voiced a common view among Palestinians that they were betrayed by the Arab states.

"We were forced from our homes and told not to fight because they had seven armies," he said. "But they were defeated like butterflies."

In the main West Bank city of Ramallah, several hundred people turned out for a demonstration, some holding pictures of Yasser Arafat, the late Palestinian leader who died in 2004.

Several dozen Israeli peace activists mounted a demonstration against Jewish settlements in the West Bank city of Hebron, saying they made it hard for a viable Palestinian state to be established.

"It's been 40 years. We are asking the Israeli settlers in Hebron to come back to Israel. There's room for everyone," said left-wing member of parliament Chaim Oron.

But settler Rosen Ben Chamen said: "Hebron was a Jewish city when Europe was still a swamp." (Additional reporting by Nidal al-Mughrabi in Gaza, Mohammed Assadi and Wafa Amr in Ramallah, Haitham Tamimi in Hebron and Alastair Macdonald in Jerusalem)

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