By Wafa Amr

RAMALLAH, West Bank, May 10 (Reuters) - The Palestinians' top peace negotiator said on Saturday he feared a criminal investigation of Israeli Prime Minister Ehud Olmert could damage the chance of a deal this year on Palestinian statehood.

Though Olmert has denied wrongdoing in his ties to an American businessman at the centre of a police inquiry into allegations of bribery, the prime minister said on Thursday he would resign if indicted -- a likely setback to efforts to secure a peace accord from the U.S.-sponsored talks before U.S. President George W. Bush steps down in January.

"The developments in the Israeli political system and the investigation could make it difficult to conclude an agreement this year," Ahmed Qurie, a former Palestinian prime minister who now leads peace talks, said in a speech in Ramallah.

"I am not optimistic that an agreement can be concluded this year, but I am also not pessimistic," he said, echoing concerns expressed by more junior members of Palestinian President Mahmoud Abbas's administration after the affair broke last week.

Bush is scheduled to visit Israel on Wednesday to celebrate its 60th anniversary and give a high-profile push to talks on creating a Palestinian state alongside the Jewish state.

The White House, already at pains to overcome mutual recrimination bogging down Israeli-Palestinian diplomacy, has played down the potential fallout of Olmert's legal woes, noting he is not the only Israeli leader committed to peacemaking.

If Olmert were to step down, it could trigger snap elections that opinion polls suggest would catapult hawkish former Prime Minister Benjamin Netanyahu -- a vocal opponent of ceding occupied West Bank land to Abbas -- back to power.

Olmert has the option of taking a leave of absence, in which case his powers would be assumed by Foreign Minister Tzipi Livni -- Qurie's counterpart in the negotiations. Israel's centre-left Labour party, traditionally at the vanguard of peace efforts, may break away from Olmert's coalition and run for top office.

Such a major shake up in Israeli politics could be reflected in the West Bank and Gaza Strip, Palestinian territories split between Abbas's secular Fatah and Islamist Hamas since the factions fought a brief civil war last June.

Hamas, which won elections in 2006 only to be sidelined by Abbas and the West for refusing to foreswear violence and recognise Israel, has sought reconciliation with the Palestinian president but resisted his demand to submit to his authority.

The internal Palestinian deadlock has prompted some experts to predict a new poll, though that might not favour Abbas.

"I predict early election in Israel and early election in Palestine that will bring in new leaders, not those sitting n the chairs," said Mehdi Abdel-Hadi, a Palestinian political analyst. (Writing by Dan Williams; Editing by Matthew Jones)

AlertNet news is provided by