(Updates with Abbas comment)

By Nidal al-Mughrabi

GAZA, Nov 10 (Reuters) - Palestinian Prime Minister Ismail Haniyeh said on Friday he might step aside and not head a unity government Hamas is trying to forge with the rival Fatah faction as a way to lift a Western embargo.

Haniyeh said he hoped the unity cabinet could be in place within three weeks, ending months of intermittent talks and internal violence that has raised fears of civil war.

The prime minister, a senior leader of the Islamist group, told worshippers at a mosque in the Gaza Strip that Western powers did not want him to be part of the new administration.

"(They have) one condition, that the siege will not be lifted unless the prime minister is changed," Haniyeh said.

"When the issue is like this, the siege on one hand, the prime minister on the another ... I prefer the siege be lifted and the suffering ended."

The United States and Europe imposed crippling sanctions on the Palestinian Authority when Hamas took power in March because of the group's refusal to recognise Israel and renounce violence. Israel also withheld tax and customs receipts.

Palestinian officials said this week Haniyeh would not be part of the unity cabinet. They said the prime minister had given President Mahmoud Abbas of Fatah the names of several people to succeed him, although Haniyeh denied doing so.

Haniyeh said dialogue with Fatah and other parties would resume next week after talks were suspended in the wake of the Israeli artillery shelling of the town of Beit Hanoun in northern Gaza on Wednesday that killed 19 civilians.

The toll rose after one man died of his wounds on Friday, hospital officials said.

"We have laid down the rules and the basis for the formation of a national unity government. I hope that within two to three weeks this issue will be concluded," Haniyeh said.

Abbas told reporters later in the West Bank city of Ramallah that efforts to forge a unity government "will bear fruit soon", without giving any date.

"NO CONCESSIONS"

Palestinian leaders hope the formation of a unity government, partly made up of professional experts, can lead to a resumption of direct foreign aid to the Palestinian Authority.

But Hamas insists it will never recognise Israel or join a government that does, making it unclear how a unity cabinet could meet international demands to soften its line.

"There are no concessions," Haniyeh said.

While Haniyeh spoke of one condition, the United States and Israel have said the Palestinian government had to recognise the Jewish state, renounce violence and accept past peace deals.

Hamas, which advocates Israel's destruction, accuses the West of trying to topple its administration and giving it no chance to govern. The movement took office after trouncing the once-dominant Fatah in January elections.

Fatah seeks a negotiated peace with Israel.

The sanctions have deepened economic hardship in the occupied West Bank and in Gaza, where Israeli forces have been conducting an offensive since militants abducted a soldier in late June in a cross-border raid.

Palestinians have called Wednesday's shelling of Beit Hanoun a massacre. Israel said it was the result of a "technical failure" by Israeli artillery. The army said it was targeting militants who fired home-made rockets at the Jewish state.

Speaking earlier on Thursday at a meeting of Fatah's Revolutionary Council, a key decision making body within the faction, Abbas called on the United Nations Security Council to offer protection to Palestinians after the Israeli attack. (Additional reporting by Wafa Amr in Ramallah)

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