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JERUSALEM (Reuters) - A pending U.S. framework proposal to propel stumbling Israeli-Palestinian peace talks forward chipped away on Wednesday at a troubled alliance between Prime Minister Benjamin Netanyahu and an ultranationalist ally in his governing coalition.
Adding to the fray was a warning by centrist Finance Minister Yair Lapid that any failure of U.S.-brokered peace talks could cause a "dramatic setback" in Israel's economy, citing boycott threats against Israel already heard in the West.
No date has been announced for U.S. Secretary of State John Kerry to unveil his blueprint for an Israeli-Palestinian deal, but new skirmishing between Netanyahu and far-right partner Naftali Bennett suggested crunch time was near.
Bennett's Jewish Home party advocates annexation of some of the West Bank - occupied territory that Palestinians seek for a state - and it has threatened to end its partnership with Netanyahu if, he says, any handover of land of biblical significance to Jews were in the offing.
In a hard-hitting speech to an international security conference on Tuesday, Bennett aired veiled criticism of Netanyahu - sending a signal that he believed the Israeli leader was primed to accept Kerry's peace guidelines.
"Neither our forefathers nor our descendants will forgive the Israeli leader who gives away our land and divides our capital," said Bennett, an Orthodox Jew.
In a speech at the same Tel Aviv security forum, Netanyahu said Kerry would offer "American positions" and that "Israel does not have to agree to anything the Americans present".
Israeli officials, speaking anonymously, were livid over Bennett's accusations, and he seemed to try to defuse the crisis later by saying in a speech that "if the Prime Minister was insulted I definitely regret it".
Lapid, who heads the largest centrist party in Netanyahu's government, cautioned that scuttling the peace talks could also spell trouble for Israel's export-dependent economy.
He told a conference on security near Tel Aviv that European and North American countries were likely to blame Israel for any failure in Kerry's mission.
"If the negotiations with the Palestinians get stuck or explode and we wind up in the situation of a European boycott, even a very partial one, the Israeli economy would regress, the pocket of every Israeli citizen will be hurt."
"Let's not delude ourselves, the world listens to us less and less. We must recognize that if the talks fail the world will believe they have failed because of us, and this would come at a price," Lapid also said.
New York Times columnist Thomas Friedman laid out the broad outlines of what he said was the "expected" Kerry framework proposal. An Israeli political source gave a similar account.
According to the report, the plan entails an end to the Israeli-Palestinian conflict and all claims, following a phased Israeli withdrawal from the West Bank, with unprecedented security arrangements in the strategic Jordan Valley.
The pullout, the newspaper said, will not include certain settlement blocs but Israel will offer Israeli territory to the Palestinians in compensation.
The proposal further envisages the Palestinians having their capital in East Jerusalem and recognizing Israel as the nation state of the Jewish people. It will not include any right of return for Palestinian refugees to Israel.
Palestinians under President Mahmoud Abbas in limited self-ruled areas of the West Bank seek a state covering the entire territory and the Gaza Strip with East Jerusalem as their capital. Israel pulled settlers out of Gaza in 2005 and Hamas Islamists sworn to Israel's destruction now rule the enclave.
The future of settlers on land Israel captured in the 1967 Middle East war was the core of the Netanyahu-Bennett flareup.
The dispute flared on Saturday, when an unidentified Netanyahu aide said the Israeli leader would insist Jewish settlers had a right to remain under Palestinian rule in any future peace deal.
It was, political sources later conceded, a calculated attempt to portray Abbas as a naysayer unwilling to accept the notion of a Jewish minority in his country - while Netanyahu had an Arab minority in his own.
The exercise backfired, however, when attention shifted to Bennett's angry reaction on Facebook, where he demanded Netanyahu "immediately refute this dangerous proposal".
Editing by Andrew Roche