Mr. Obama said he hasn't seen the kind of progress in negotiations that "could finally create a framework for a secure Israel living side by side in peace with a sovereign Palestine."
Asked at a news conference with Indonesia's President Suslilo Bambang Yudhoyono about Israeli settlement construction in East Jerusalem, President Obama said, "This kind of activity is never helpful when it comes to peace negotiations.
"Each of these incremental steps can end up breaking that trust between these parties," he said.
He also said his administration is making progress toward ending the misunderstanding and mistrust between Muslim countries and the United States, with efforts he characterized as "earnest" and "sustained," Still, he said the progress is "incomplete" and there is more work to do.
Though issues of terrorism and extremism often dominate the tensions between the Muslim world and the west, Mr. Obama said the relationship must expand beyond security issues.
"What we're trying to do is make sure that we are building bridges and expanding our interactions with Muslim countries," President Obama said.
President Obama raised his Mideast concerns while appearing with Yudhoyono during his first visit to Indonesia as president to the country where he lived for four years as a child. He marveled over "sights and sounds" that evoked memories of the past and said that Indonesia's landscape of today barely resembles the land where he went to live at age 6 in 1967 after his mother married an Indonesian man.
The U.S. sees Indonesia as a counterweight to China's growing strength, though President Obama said Tuesday he's not seeking to stop China's growth.
"We think China being prosperous and secure is a positive," Mr. Obama said. "We're not interested in containing that process."
More on President Obama's Asia Trip:
Still, with the controversy over how China values its currency looming as Mr. Obama heads to the G-20 economic summit in South Korea later this week, the president said all countries must operate within, "an international framework and sets of rules in which countries recognize their responsibilities to each other."
Without mentioning China by name, he pointedly noted that the global economy hasn't achieved balanced growth.
"We have seen some countries run up very big surpluses and intervening significantly in the currency markets to maintain their advantage," Obama said.
President Obama will meet with Chinese President Hu Jintao Thursday, but officials say they don't expect the currency issue to be resolved.
The president said he believes the administration has improved relations with the Muslim world but called it an "incomplete project," saying much more work needs to be done.
Mr. Obama said policy differences with Muslim countries will linger, but that building better ties between the people of the United States and the Muslim world will foster improved overall relations.
He voiced support for Yudhoyono's efforts to nurture a rapidly growing society even in a time when Indonesia has been hit by earthquakes, a tsunami, and now a volcanic eruption. Concerns about volcanic ash caused the White House to shorten President Obama's stay here and expedite his takeoff Wednesday for the G-20 summit in Seoul.
The White House announced the president would depart Indonesia about two hours earlier than planned so Air Force One can be out of Jakarta air space before a predicted ash cloud moves into the area, reports CBS News White Hosue correspondent Peter Maer.
Mount Merapi, Indonesia's most volatile volcano, began erupting two weeks ago, unleashing a flood of volcanic gas, rock and debris that smothered whole villages and cut down people who tried to fleeing.
As scheduled, the trip was less than 24 hours, with Mr. Obama arriving late afternoon Tuesday and leaving midday Wednesday. The trip was shoehorned into a jam-packed 10-day Asia trip, between three days spent in India and economic meetings in South Korea and Japan that start Thursday.
President Obama and first lady Michelle Obama arrived on a gray, humid day in Indonesia's capital, and were greeted by dozens of dignitaries at Istana Merdeka, a white columned presidential palace reminiscent of the White House. Mr. Obama greeted some of the officials in Indonesian as he shook their hands.
Indonesians all over this country of more than 17,000 islands gathered around television sets in their houses, coffee shops and office buildings as Obama's plane touched down.
Notwithstanding the likely change in schedule for his time here, President Obama's quick stop to visit a country that is increasingly important player in Asia allowed him to speak to the values of democracy and religious tolerance and reflect on his time here as a boy.
The U.S. has increasingly embraced Indonesia as a moderate Muslim nation and partner in counter-terror efforts in the wake of attacks in Bali, Jakarta and elsewhere in the region between 2002 and 2005. The nation of 250 million people is made up of a string of islands stretched through the Indian Ocean between Australia and Malaysia.
"Lots of U.S. interests and lots of challenges and opportunities intersect in Indonesia," Ben Rhodes, deputy national security adviser for strategic communications, told reporters Monday.
Concerns over the volcanic ash cloud forced the White House to move up events Obama has planned for Wednesday, including a stop at Jakarta's Istiqlal Mosque and a speech at the University of Indonesia. However, nearly all of the press traveling with President Obama opted to leave Indonesia before the speech in order to make it to the next stop - South Korea - ahead of the president.