The premier made the admission at recent meetings with senior Israeli officials and Palestinian Interior Minister Abd al-Razek al-Yihiya, the paper said.
Israeli troops maintain a strong presence in West Bank towns including road blocks, amid fears that Palestinian President Mahmoud Abbas's forces are too weak to prevent militant attacks against Israel. Pro-presidential Fatah security forces suffered a humiliating defeat in June to Islamist group Hamas in the Gaza Strip, due to lack of arms and organization.
Originally, the Palestinian premier and interior minister made the transfer of some West Bank cities to PA security control one of their key requests of Israel. Israel did not immediately reject the request, but asked that the PA security forces be prepared to take action against any militants that attempt terrorist attacks against Israel.
Haaretz said Fayad had retracted his earlier demand that large cities in the West Bank be returned to PA forces' control.
"After we realized that there were Israeli limitations on our demands to expand the 'fugitives agreement,' and the security forces in the West Bank are still not prepared to take on responsibility in the cities, Fayad changed his stance on the matter of negotiation," a senior Palestinian official was quoted by Haaretz as saying.
Israeli Prime Minister Ehud Olmert met with Abbas in Jericho earlier in the day for talks focused on preparations for a regional summit scheduled for November in Washington. The visit to the relatively peaceful city marked the first time an Israeli prime minister has visited the Palestinian territories since the intifada, launched in September 2000. The meeting took place amid tight security arrangements.
Since the Hamas takeover, Israel, Western nations and moderate Arab states have given their backing to Abbas, and Tel Aviv has moved to strengthen Fatah's control of the West Bank, releasing Fatah fighters, and returning previously-withheld tax revenues.