(Adds Iran's reaction) By Katherine Baldwin DUBAI, Dec 20 (Reuters) - British Prime Minister Tony Blair urged Middle Eastern states on Wednesday to help rein in the "forces of extremism" in Iran and to advance peace between Israelis and Palestinians. Blair, on the final day of what may be his last Middle East tour as prime minister, said Iran was openly supporting terrorism in Iraq, undermining the Lebanese government and blocking Israeli-Palestinian peace. The Islamic Republic has not recognised Israel and last year President Mahmoud Ahmadinejad called for Israel to be "wiped off the map". Tehran said Blair's comments were "hateful". "Britain's negative and divisive approach and the war mongering and unilateral policies of (U.S. President George W.) Bush and Blair have caused tension and extremism in the region," said Iran's Foreign Ministry spokesman Mohammed Ali Hosseini. Blair's spokesman earlier dismissed suggestions his comments on Iran were designed to pit the region's Sunni Muslims against Shi'ite Iran, saying the prime minister worked with all faiths. Tehran, under Western pressure over its nuclear programme, also backs the Lebanese guerrilla group and opposition party Hezbollah, which is leading a drive for early elections after failing to obtain veto power in government. Blair, who will leave office next year and whose popularity has been eroded by the Iraq war, rejected suggestions American or British action in the Middle East was fuelling terrorism. "If our policy has a fault, it is that we are too shy of acting boldly to bring about change, to give succour to those trying to live for the better," Blair said in Dubai. "We must mobilise our alliance of moderation in this region and outside it and defeat the extremists" whose ideas are based on a 'warped' interpretation of Islam," he added. PIN BACK IRAN Blair, who believes he has made progress in exploring ways to revive Israeli-Palestinian peacemaking on his trip, said the struggle between "moderates and extremists" would affect the security of the wider world. He called on moderate leaders across the Middle East to join a "monumental struggle" between democracy and extremism. "We must recognise the strategic challenge the government of Iran poses; not its people, possibly not all of its ruling elements, but those presently in charge of its policy," he said. Some Iraqi politicians, mainly Sunni Muslims, accuse Tehran of fuelling sectarian violence by supporting Shi'ite militias. "Our response should be to expose what they are doing, build the alliances to prevent it and pin them back across the whole of the region," Blair said. Blair plans to hold talks with world leaders in early 2007 on delivering a package of aid for Palestinian President Mahmoud Abbas. Abbas has called for early elections after failing to form a unity administration with Hamas, which won elections in January but is being boycotted by the West because of its refusal to recognise the state of Israel. Blair listed three priorities: to give Abbas's office the capacity to improve Palestinians' lives; to engineer an early meeting between Abbas and Israeli Prime Minister Ehud Olmert, and to relaunch the political process for a two-state solution.
