Israeli officials said Olmert envisages agreeing a joint document with Mahmoud Abbas, the Palestinian president, that sets out borders for a future Palestinian state, security arrangements and a way to deal with millions of Palestinian refugees, but leaves out the contentious issue of Jerusalem.
'Red line' issue
However, Nabil Abu Rdainah, a spokesman for Mahmoud Abbas, the Palestinian president, said that Jerusalem was a "red line" for Palestinians, which expects to make east Jerusalem the capital of a Palestinian state.
"We will not accept any agreement that excludes Jerusalem," he said.
"We still have six months, and that means Israel isn't serious about reaching an agreement according to Annapolis and Bush's vision."
The end of year deadline was set at a US-brokered meeting between Olmert and Abbas in Annapolis, Maryland last November. Earlier this month, the Israeli prime minister said the two sides had never been so close to a deal.
East Jerusalem was captured when Israeli forces pushed out Jordanian troops during the 1967 war, however its annexation has never been recognised by the international community.
Palestinians account for about one-third of the 750,000 people who live in Jerusalem. They are not Israeli citizens, but have access to Israeli social benefits and can move throughout Israel, unlike the Palestinians of the West Bank and Gaza.
In his remarks to the Foreign Affairs and Defence Committee, Olmert suggested that Israeli control of Jerusalem was a security issue.
"Whoever thinks the basic pattern of life in Jerusalem can continue with 270,000 Arabs in east Jerusalem must take into account that there will be bulldozers, trucks and private cars, and no way of preventing terror attacks of this kind," Olmert said.
East Jerusalem residents "can move freely around the entire country and there is no way of knowing what they might do," the official quoted him as saying.
Two Palestinian construction workers recently carried out attacked where earth-moving vehicle were used to ram into into others vehicles in Jerusalem.
Mustapha Barghouti, an independent Palestinian MP, said that Olmert's remarks showed that Israel was not serious about peace.
"Olmert's declaration confirms the absence of an Israeli partner for peace at the moment and the lack of seriousness on the side of the Israeli government to achieve negotiated results," he said.
"It also proves that Annapolis process has failed completely because the US does not want to pressure Israel to abide by the principles of the Quartet, by the road map, and the implementation of a real peace process."
However, the White House said on Monday that it was continuing to press both sides to reach a peace deal.
"I think we've always said that we wouldn't be able to get a final peace deal in terms of everything being resolved, but we would have this way forward that would outline all the steps that they would have to take to move forward," Dana Perino, White House spokeswoman, said.
Condoleezza Rice, the US secretary of state, will host a three-way meeting with Israeli and Palestinian negotiating teams in Washington later this week, but Israeli officials have played down the chances of a breakthrough.