UPDATE 5-U.N. rights inquiry says Israel must remove settlers

* Israel refused to cooperate with U.N. investigation

* U.N. report-Israeli settlements are "creeping annexation"

* Says settlements prevent a viable Palestinian state

* Israel rejects report, while top PLO official welcomes it

GENEVA, Jan 31 (Reuters) - U.N. human rights investigators

called on Israel on Thursday to halt settlement expansion and

withdraw all half a million Jewish settlers from the occupied

West Bank, saying that its practices could be subject to

prosecution as possible war crimes.

A three-member U.N. panel said private companies should stop

working in the settlements if their work adversely affected the

human rights of Palestinians, and urged member states to ensure

companies respected human rights.

"Israel must cease settlement activities and provide

adequate, prompt and effective remedy to the victims of

violations of human rights," Christine Chanet, a French judge

who led the U.N. inquiry, told a news conference.

The settlements contravened the Fourth Geneva Convention

forbidding the transfer of civilian populations into occupied

territory and could amount to war crimes that fall under the

jurisdiction of the International Criminal Court (ICC), the

United Nations report said.

"To transfer its own population into an occupied territory

is prohibited because it is an obstacle to the exercise of the

right to self-determination," Chanet said.

All U.N. member states must comply with their duty under

international law on the settlements, she said. "We have

highlighted states' responsibility because the facts we denounce

are known. The problem is nobody is doing anything about it."

U.N. Secretary-General Ban Ki-moon reacted to the inquiry's

findings by repeating his position that "all settlement activity

in the occupied Palestinian territory, including East Jerusalem,

is illegal under international law," according to a statement.

In December, the Palestinians accused Israel in a letter to

the United Nations of planning to commit what they said were

additional war crimes by expanding Jewish settlements after the

Palestinians won de facto U.N. recognition of statehood, and

said Israel must be held accountable.

Israel has not cooperated with the probe set up by the Human

Rights Council last March to examine the impact of settlements

in the territory, including East Jerusalem. Israel says the

forum has an inherent bias against it and defends its settlement

policy by citing historical and biblical links to the West Bank.

Israel's foreign ministry swiftly rejected the report as

"counterproductive and unfortunate." Palestinians welcomed the

report, saying it vindicated their struggle against Israel.

"The only way to resolve all pending issues between Israel

and the Palestinians, including the settlements issue, is

through direct negotiations without pre-conditions.

Counterproductive measures - such as the report before us, will

only hamper efforts to find a sustainable solution to the

Israel-Palestinian conflict," Israel's Yigal Palmor said.

But Hanan Ashrawi, a senior PLO official, told Reuters in

Ramallah: "This is incredible. We are extremely heartened by

this principled and candid assessment of Israeli violations."

The independent U.N. investigators interviewed more than 50

people who came to Jordan in November to testify about

confiscated land, damage to their livelihoods including olive

trees, and violence by Jewish settlers, according to the report.

"The mission believes that the motivation behind this

violence and the intimidation against the Palestinians as well

as their properties is to drive the local populations away from

their lands and allow the settlements to expand," it said.

"CREEPING ANNEXATION"

About 250 settlements in the West Bank, including East

Jerusalem, have been established since the 1967 Middle East war

and they hold an estimated 520,000 settlers, according to the

U.N. report. The settlements impede Palestinian access to water

and farmland.

The settlements were "leading to a creeping annexation that

prevents the establishment of a contiguous and viable

Palestinian state and undermines the right of the Palestinian

people to self-determination," it said.

Chanet said firms working in the territories must uphold

human rights. France's Veolia, which built Jerusalem's

light rail linking the western side of the city to the eastern

side annexed by Israel after the 1967 war, won a case brought

against it in a Nanterre court, whose ruling that it had not

violated the Geneva Conventions is now on appeal, she said.

After the General Assembly upgraded the Palestinians' status

at the world body, Israel said it would build 3,000 additional

settler homes in the West Bank and East Jerusalem - areas

Palestinians want for a future state, along with the Gaza Strip.

"I think that maybe it will help in the negotiation just to

see that now, and especially when Palestine has been recognised

as a state, things might change. Maybe, we hope. And now there

is a new government in Israel," Chanet said.

"So things are moving. So we hope that our report will be in

the middle of this movement."