The Palestine Football Association (PFA) dropped its motion on Friday asking for Israel to be suspended by FIFA.
The motion had been included on the agenda at the FIFA Congress but PFA president Jibril Rajoub said he had been persuaded to back down. "I decided to drop the suspension but it does not mean that I give up the resistance," he said.
The PFA has accused Israel of hampering its activities and restricting the movement of players between the Gaza Strip and the Israeli-occupied West Bank.
Israel cites security concerns for the restrictions it imposes and the country's football association has argued that it has no control over security forces.
Soccer's world governing body has been trying to settle the matter for two years and Blatter this month travelled to the region and meet Israel's Prime Minister Benjamin Netanyahu and Palestinian President Mahmud Abbas.
"A lot of colleagues who I respect and I appreciate explained to me how it is painful for them to hear in this family about the issue of suspension," said Rajoub.