Any deductions, say sources familiar with the US decision, would come out of later instalments.

Earlier this year, the US agreed to extend up to $9 billion in loan guarantees to Israel, with up to $3 billion available in the current fiscal year that ends on 30 September.

Israel sold $1.6 billion in bonds in the US on Tuesday - the start of its plan to raise money using the fresh US loan guarantees.

It needs the cash to weather a deep recession and fiscal crisis stemming largely from the three-year-old Palestinian revolt against Israeli occupation.

Cuts or restrictions in US aid to Israel have long been urged by critics of Israel’s settlement policy, who point out that building settlements on occupied land is illegal under international law.

Deductions

The sources, who are familiar with the US decision but asked not to be named, said any reductions would come out of the remaining $1.4 billion in loan guarantees.
 
"The $1.6 (billion) will be guaranteed," a US official told Reuters. "We will deduct it from the remainder after guaranteeing the $1.6 (billion)."

Israeli Premier Ariel Sharon (L)
has avoided strong US criticism

US officials said the Bush administration had to report to Congress on the matter by the end of September. This implied a speedy decision on possible deductions, although US officials said it could be delayed.

Under US law, the State Department must deduct from the guarantees, on a dollar for dollar basis, sums that are spent "for activities which the president determines are inconsistent with the objectives and understandings reached between the United States and the government of Israel".

Settlements

Under the US-backed Middle East "road map" peace plan, Israel is required to freeze illegal settlement activity on the occupied West Bank. Its refusal so far to do so, coupled with subsequent Palestinian bomb attacks on Israeli targets, have stalled the road map plan.

The object of any cuts would be to ensure no US money funds illegal settlements. White House officials said such deductions were not unusual and were done annually from 1992 to 1998.

White House spokesman Scott McClellan said the US still had concerns about the Apartheid wall Israel was building through the West Bank.

US President George Bush has admitted the Apartheid wall – which cuts through Palestinians towns and farms – makes it hard to develop a viable Palestinian state. But Washington has not decided whether to make any related deductions from the loan guarantees.

Israel receives nearly a third of all US foreign grants - close to 20 times the amount going to the Palestinians. Under Israeli occupation, 70% of Palestinians survive on less than $2 per day, according to the World Bank.