Christian Aid, a UK-based aid agency, said on Thursday that without urgent international intervention generations of Palestinians and Israelis face a future of crippling poverty and relentless insecurity.
Its report, Facts on the Ground, explains how Israel is taking more land from the occupied West Bank for Jewish settler roads and settlements.
As a result, Christian Aid says, poverty and unemployment levels are rising, malnutrition and anaemia are mounting, and farmers are being prevented from tilling their land.
In the West Bank, illegal Jewish settlements control 42% of the land.
Israelis-only roads and highways criss-cross Palestinian territory, intersecting villages in the West Bank and cutting the Gaza Strip in three.
Unable to get their goods to market or travel to work, Christian Aid says Palestinians are seeing their economy strangled and their future vanishing before their eyes.
'Politics of separation'
The aid agency adds the separation barrier which surrounds large parts of the West Bank is the starkest sign yet of Israel's politics of separation.
For Palestinians, there is no freedom of movement between its two sides except through Israeli-controlled military checkpoints.
"Israel has steadily built and then expanded settlements on the land which it has occupied since 1967 in violation of international law," the report said.
"These [Israeli] settlements have all but destroyed the possibility of a viable Palestinian state"
Christian Aid report
"The announcement, in August 2004, that another thousand homes were to be built in the West Bank is a sign of the impunity with which Israel operates.
"This steady expansion, together with the construction of the separation barrier through the West Bank is creating ever greater hardship.
"These settlements have all but destroyed the possibility of a viable Palestinian state."
Christian Aid says the two-state solution would make it possible for Palestinians to tackle the endemic poverty that permeates the Occupied Palestinian Territories.
It also offers Palestinians and Israelis the prospect of security and sovereignty that both peoples so desperately need.
"The increasing culture of violence, marked by suicide bombings, overwhelming military force in civilian areas and wanton destruction, threatens people in the region and beyond," said the Christian Aid report.
"But the policies of separation and division which we see today are heightening, not solving, the conflict.
"The UK, Irish and EU governments have a legal obligation, under international law, to ensure they hold Israel to account for its actions in the Occupied Palestinian Territories."
Israel says the separation barrier
helps keep out 'suicide bombers'
In particular, Christian Aid recommends that Jewish settlements and their infrastructure be dismantled, and construction of the separation barrier around the West Bank be halted.
It also recommends that Palestinians be allowed to hold free and fair elections in the Occupied Territories.
Following the report's publication, Chris Doyle, director of the Council for Arab-British Understanding, urged the British government to take seriously Christian Aid's findings and recommendations.
"It is crystal clear that action is urgently needed to prevent both a full scale humanitarian disaster, but also the death of the two state solution around which an international consensus has so successfully been built over the last two decades.
"For too long successive Israeli governments have been allowed to ignore international criticism about the settlement policy and the building of the separation wall.
"It is also to be hoped that the British Prime Minister, when as promised gets re-engaged with the Israeli-Palestinian issue after November, urgently considers these recommendations."
"For too long successive Israeli governments have been allowed to ignore international criticism about the settlement policy and the building of the separation wall"
Council for Arab-British Understanding
Aljazeera.net's correspondent in the West Bank says a significant minority of Palestinians who believe Israel will never allow a viable Palestinian state now favour a one-state solution.
This would entail Jews, Muslims and Christians living side by side in all of historic Palestine on the basis of equal rights for all.
However, the main obstacle to this solution is Israel's fear that it would effectively signal the end of Zionism and its elevation of Jews above other peoples.
Israel, meanwhile, argues it is unrealistic for it to return to its 1967 boundaries as West Bank settlements have become large population centres.
And it says it has been forced to build the separation wall to keep out Palestinian "suicide bombers" intent on killing Israeli civilians.