The International Crisis Group (IGC), a conflict resolution organisation, said on Wednesday that Iraqi confidence in the US "is in freefall".
Soaring resentment feeds anti-US violence, making the transition process a source of, not the solution to, the US's legitimacy deficit, said the Brussels-based group.
Washington said its initial objective was to turn Iraq into a model for the region - a democratic, secular and free-market oriented government, sympathetic to US interests, not openly hostile towards Israel, and possibly home to long-term American military bases.
But the Bush-administration now needs to limit its ambitions and focus on achievable goals, said the IGC.
Namely, it should gradually disengage politically and militarily from Iraq and let Iraq disengage politically from it.
"The credibility of Iraqi institutions depends essentially on their ability to respond to the Iraqi population's needs and aspirations, which inevitably will entail distancing themselves from the US-led occupation"
International Crisis Group
"Washington has to realise - you occupy the Iraq you have, not the Iraq you might wish to have later," said Robert Malley, director of the IGC's Middle East/North Africa Programme.
Moreover, the IGC said the US should design a counter-insurgency strategy which is less focussed on militarily eliminating its opponents in Iraq, thus gaining more support within the country.
The report said Iraqis must believe they are building a unified, independent state which must define itself at least partially in opposition to US policies or risk provoking the ire of many of its own citizens.
"The credibility of Iraqi institutions depends essentially on their ability to respond to the Iraqi population's needs and aspirations, which inevitably will entail distancing themselves from the US-led occupation," said Peter Harling, the IGC's Middle East analyst.