The prime minister of Israel, Benjamin Netanyahu, signaled for the first time Sunday that he was willing to limit, though not completely halt, construction in the West Bank settlements after a partial building moratorium expires later this month. The hints of flexibility came as diplomats worked to defuse a potential crisis over settlement building that threatens to derail fledgling Israeli-Palestinian peace talks. Also Sunday, three Palestinians, including a man in his 90s and his teenage grandson, were killed in northern Gaza by Israeli mortar fire, according to local residents. An Israeli military spokesman said Israeli forces had fired at, and hit, a group of people seen carrying a rocket-propelled grenade. Palestinian leaders in the West Bank, who recently resumed direct peace talks with the Israelis after a 20-month hiatus, have warned that a renewal of Israeli construction in the settlements would spell the end of the negotiations. Hamas, the Islamic militant group that controls Gaza, is not a party to the talks. Netanyahu faces strong opposition from within his governing coalition to any extension of the moratorium, which is due to end Sept. 26. In a meeting Sunday with Tony Blair, the envoy of the quartet of peacemakers -- the United States, United Nations, European Union and Russia -- Netanyahu said the Palestinians wanted 'zero building in Judea and Samaria,' calling the West Bank by its biblical names, 'and that will not happen. Israel cannot continue the freeze.' 'On the other hand,' he said, according to a diplomat who was briefed on the meeting but spoke on the condition of anonymity because he was not authorized to speak about it publicly, 'we will not build all the tens of thousands of housing units that are waiting in the planning pipeline.' The moratorium, which began in November, allowed for limited construction of public buildings in West Bank settlements and for the completion of thousands of housing units that were already under construction. The impending crisis is far from resolved, but a Western official familiar with the issue said it was clear that both sides wanted to find a solution. 'There is an enormous desire on both sides not to let this go down, so there is a lot of creative thinking going on,' he said. Netanyahu and the Palestinian president, Mahmoud Abbas, are scheduled to meet again Tuesday in the Sinai resort of Sharm el Sheik, Egypt. They will be joined by Secretary of State Hillary Rodham Clinton, and the issue of settlement construction is expected to loom large. While the leaders' discussions on the subject have largely taken place discreetly and behind closed doors, President Barack Obama openly called on Netanyahu to extend the moratorium during a news conference at the White House on Friday. 'What I've said to Prime Minister Netanyahu is that given, so far, the talks are moving forward in a constructive way, it makes sense to extend that moratorium,' Obama said. Earlier Sunday, at a meeting of his Likud Party ministers, Netanyahu also suggested that the construction of settlement housing should not be a matter of all or nothing, according to an official who was in the room. One of the ministers, Michael Eitan, said after the meeting that 'the freeze will end, of course, on Sept. 26 without the need for any action, because it will expire.' But, he added, 'the renewal of settlement requires a Cabinet discussion about the goals of settlement in the political conditions of today versus the settlement goals set forth in previous years, which have apparently changed.' 