(Adds Hamas comment) By Sophie Walker LONDON, Jan 31 (Reuters) - The West's isolation of the Hamas-led Palestinian government has served only to push it closer to Iran, a British parliamentary committee said on Wednesday. Hamas trounced the more moderate Fatah in an election last year. Its refusal to negotiate peace with Israel triggered a Western aid embargo which the International Development committee noted had forced it to look elsewhere for financial support amid a rising crisis of poverty and hardship. "Hamas now has closer links to governments like that of Iran than it had two years ago. We doubt whether this is a development that the international community would have intended," the committee concluded in a report on development assistance and the occupied Palestinian Territories. Malcolm Bruce, chairman of the committee, said the international community had created a dangerous situation where Islamist Hamas has no accountability either to the people or to the Palestinian Authority. "We're saying the situation is unsustainable and the government's refusal to talk to Hamas could be counter-productive," Bruce, a Liberal Democrat, said. "The clear message is that if this goes on for much longer it will effectively collapse the Palestinian state." Hamas said the report was a daring step that recognised mistakes had been made. "The European Union must take advantage of this effort ... and reconsider its policies ... and correct the relations with the Palestinian government through dialogue. The policy of isolation will not achieve anything," said Ghazi Hamad, a spokesman for the Hamas-led Palestinian government. PRESSURE ON ISRAEL The report also urged the international community to hold Israel to its promise of implementing an agreement with Palestinians, dating back to November 2005, to facilitate the movement of people and goods within the Palestinian territories. In order to put pressure on Israel, Britain should push the EU to consider suspending its Association Agreement -- a preferential trade pact with Israel -- until there are improvements in those access arrangements, it said. The committee also concluded that the so-called Temporary International Mechanism -- created to provide aid directly to the Palestinians while the boycott of Hamas continues -- was not a suitable fix. "The Temporary International Mechanism was a timely response to the crisis ... but is insufficient to cope with it," the report concluded. "Increasing donor assistance is not the answer to the problems facing the Palestinians." The European Union spent 680 million euros on aid to the Palestinians in 2006, of which 200 million went through the mechanism, according to Foreign Office figures. Britain channelled 70 million pounds through the TIM. A Foreign Office spokesman declined to comment on the report. Western countries have said they will maintain the boycott on Hamas unless it renounces violence, recognises Israel's right to exist and agrees to abide by past peace agreements. Bruce said it was not enough for Britain to hold its breath and hope for a breakthrough in the peace process. "Over history we've spoken to terrorist organisations like the IRA. That kind of contact has to happen (with Hamas)," he said. (additional reporting by Nidal al-Mughrabi in Gaza)
