By Sue Pleming

WASHINGTON, Jan 30 (Reuters) - The Gaza border breach has undermined the Bush administration's strategy of isolating Hamas and experts say such crises dim U.S. chances of getting an Israeli-Palestinian peace treaty by the end of the year.

"Hamas not only blew a hole in the wall but they also blew a hole in the whole policy of continued isolation of Hamas," said Bruce Riedel, a former CIA analyst now with the Saban Center at the Brookings Institution.

Islamist militants blasted a hole in the border between the Hamas-run Gaza Strip and Egypt last week, allowing hundreds of thousands of Gazans through the gap to buy food and other goods unavailable due to an Israeli blockade.

Israel imposed the blockade after Palestinians fired hundreds of home-made rockets at Israeli border towns in the first half of January. Israeli officials say the number of attacks has now gone down but they fear Hamas used the opportunity to smuggle weapons and explosives back into Gaza.

Analysts say the frontier breach probably boosted the popularity of Hamas among Palestinians, both in Gaza and the Israeli-occupied West Bank.

That was the exact opposite of what Washington wants as it tries to strengthen the more moderate Palestinian President Mahmoud Abbas whose Fatah party is in charge in the West Bank.

Gaza border crossings are a battleground in the power struggle between Hamas, which seized control of Gaza by force last June and refuses to negotiate with Israel, and Abbas who is taking part in talks with Israel launched by President George W. Bush last November in Annapolis.

"The general conclusion of the past few days is that Hamas forces are very much in control of Rafah," said former U.S. ambassador to Israel and Syria, Ed Djerejian.

He said the crisis had enabled Hamas to drive home the fact that they could not be shunned or ignored. The message from Hamas, he said, was, "You have got to deal with us."

The United States brands Hamas a terrorist group and spearheaded a Western embargo against it after the Islamist militants trounced Fatah in January 2006 elections.

"NO PERFECT OPTIONS"

Egypt was negotiating the border dispute on Wednesday with Hamas and Abbas, with Abbas pushing for his own forces to control the border along with European monitors.

A senior U.S. official conceded any arrangement would likely involve the Egyptians having to deal with Hamas because it runs Gaza.

"There are probably no good or perfect options," said the official, who spoke on condition he was not named as the issue is being negotiated.

But he said the border crisis would not shift the U.S. policy of isolating Hamas. Neither would it scupper peace moves between Abbas and Israeli Prime Minister Ehud Olmert.

"We should not be breathless or panicked. I think these kinds of things are going to happen," the official said.

Former U.S. Middle East negotiator Aaron Miller said the chances Bush could clinch a peace deal in his final year in office were receding.

"Hamas has tremendous leverage and can act in many ways that can frustrate, undermine and weaken Olmert's capacity to negotiate seriously, Abbas's authority and legitimacy and the prospects for a serious negotiation," he said.

Several Middle East experts said the United States was naive in believing it could ignore Hamas.

"Wishing Gaza away will not work," said Daniel Levy, a former Israeli negotiator now with the New America Foundation.

"You have to somehow have an arrangement that does not exclude Hamas and invite them to be the spoiler. If you don't do that, the elephant will keep sticking its trunk out the room and the room will get smashed apart," he said.

Recent events in Gaza and fears of a humanitarian crisis may prod Arab states such as Saudi Arabia to once again try to reconcile Hamas and Fatah as they did last year, a move that angered the United States.

Middle East expert Nicolas Pelham of the International Crisis Group said it was time for Washington to have a "reality check" and engage Hamas.

"The great difficulty is that all parties have climbed so far up the tree, it's hard to see how they can save face and climb down." (Editing by Alan Elsner)

AlertNet news is provided by