"We are going through a period where we feel that things are moving," Merkel said in a speech at Hebrew University in Jerusalem, where she received an honorary doctorate.

"There is a window of opportunity... The Arab world is ready to talk about the Mideast conflict and its solutions. There is a real chance of reaching a breakthrough and we must grasp it," she said, according to the Hebrew translation of her remarks in German.

Merkel met shortly with Israeli Prime Minister Ehud Olmert after her arrival on Saturday and will meet again with him on Sunday evening.

Palestinian President Mahmud Abbas, said his parley with her in Ramallah on Sunday was important and focused on "the political movements the area is witnessing," as well as on ways of spurring on the peace process, according to German news agency DPA.

Merkel's trip comes amid increased international efforts to restart stalled Middle East peace talks and follows last week's Arab summit in Riyadh that revived a five-year-old peace plan for the region.

The Arab proposal offers Israel peace and normal ties if it withdraws from all land seized in the 1967 Middle East war and allows for the creation of a Palestinian state and the return of Palestinian refugees.

Israel welcomed the prospect of dialogue with moderate Arab states, but has stopped short of endorsing the blueprint as is, saying negotiations were needed on the refugee issue.

Merkel hails Arab plan

The German chancellor hailed the blueprint, along with the creation of the new Palestinian unity government which united the radical Islamist Hamas with Western-backed moderates, and which Israel has refused to recognize.

The European Union's official decision on Saturday to deal with cabinet members not belonging to Hamas, considered a terror group by the West, was likely to be a sticking point in Merkel's talks with Olmert later on Sunday.

"There is going to be talk about the issue," government spokeswoman Miri Eisin told AFP. "Israel continues to say clearly that the new Palestinian government headed by (Hamas Premier) Ismail Haniya openly supports terror, funds terror and we have stated clearly that we that all members of this government... should not be recognized," Eisin said.

Merkel said that she would tell Abbas that the new Palestinian coalition must agree to abide by Quartet conditions of renouncing violence, recognizing Israel and agreeing to abide by past peace deals.

She said she would also urge the new coalition to secure the release of an Israeli soldier seized nine months ago by Gaza-based militants, including the armed wing of Hamas -- a major stumbling block in Israeli-Palestinian relations.

"We are still waiting for a serious gesture of goodwill, the release of soldier Shalit, and we expect the unity government to recognize the Quartet conditions," she said.

EU aid to Palestinians still frozen

The Quartet slapped a diplomatic and direct aid embargo on the Palestinian government last year after Hamas formed a cabinet alone.

Since the inauguration of a unity cabinet on March 17, the European Union -- the largest donor of aid to the Palestinians -- has eased the diplomatic freeze, meeting with non-Hamas ministers, but has not lifted the embargo on direct aid to the cabinet.

Merkel began her regional tour in Jordan on Saturday and is due to end her visit to the region in Lebanon on Monday.