Such a state will provide Palestinians with the chance to lead lives of freedom, purpose and dignity. And such a state will help provide Israelis with something they have been seeking for generations: to live in peace with their neighbours."
'Time right'
Bush told delegates from more than 50 countries and organisations: "In light of recent developments, some have suggested that now is not the right time to pursue peace. I disagree.
"I believe that now is precisely the right time to begin these negotiations - for a number of reasons."
He said: "The time is right because a battle is under way for the future of the Middle East - and we must not cede victory to the extremists."
And in remarks that struck a sensitive Palestinian nerve, Bush said "the United States will keep its commitment to the security of Israel as a Jewish state and homeland for the Jewish people".
"This settlement will establish Palestine as the Palestinian homeland, just as Israel is the homeland for the Jewish people."
More talks planned
The first peace talks are to be held on December 12 and are to continue biweekly after that, Bush said.
He was followed at the podium in the memorial hall of the naval academy by Mahmoud Abbas, the Palestinian president, and Ehud Olmert, the Israeli prime minister.
Abbas laid out some core issues in his speech.
"Tomorrow, we have to start comprehensive and deep negotiations on all issues of final status, including Jerusalem, refugees, borders, settlements, water and security and others," he said.
He expressed the Palestinians' desire for East Jerusalem to be the capital of "our state".
Abbas said: "The exceptional opportunity that the Arab, Islamic and international prescience brings us today coupled with overwhelming Palestinian and Israeli public opinion in support of Annapolis, must be seized in order to be a launching pad for a negotiations process."
'Painful compromise'
Olmert, for his part, reached out to Arab delegates by using the Arabic phrase for "welcome".
"I have no doubt that the reality created in our region in 1967 will change significantly," he said.
"While this will be an extremely difficult process for many of us, it is nevertheless inevitable. I know it. Many of my people know it. We are ready for it."
Olmert said: "We want peace. We demand an end to terror, incitement and hatred. We are willing to make a painful compromise, rife with risks, in order to realise these aspirations."
The issue of Jewish West Bank settlement building was not mentioned by him.
Months of diplomacy
The first major Israeli-Palestinian conference in seven years got under way on Tuesday in Annapolis in the state of Maryland after months of diplomacy.