Fatah tentatively accepted Wednesday an offer from Hamas to become the junior partner in a coalition government. Meanwhile, Iran offered to help finance a Hamas-led Palestinian Authority while the Arab League called on the European Union not to politically isolate the incoming government, but to try to convince it to seek peace with Israel.

The head of Fatah's bloc in Parliament told reporters after talks with Hamas leaders that the movement had agreed in principle to join the Cabinet, although the two sides still needed to reach an accord.

"There is an agreement in principle and the intention is there [to participate in a coalition] but we must await the program," Azzam al-Ahmad said.

"If we reach agreement, we will participate. If not, then we will be a construct-ive opposition."

Mahmoud al-Zahhar, who led the Hamas delegation at the talks in Gaza City, said "all the parties, including our brothers in Fatah, intend to participate in the government." He added: "We have agreed to continue our discussions."

Outlining what appeared to be a major sticking point, Ahmad told Reuters that Fatah would insist a Hamas-led administration adopt President Mahmoud Abbas' vision of negotiating peace with Israel.

On Tuesday, Abbas formally handed prospective Hamas premier Ismail Haniyya a letter tasking him to form the next government.

Israel has said it could not consider dealing with Hamas until the group recognized it, abandoned armed resistance and accepted past interim peace accords.

"We do not conduct negotiations with a Hamas Authority. We will reduce contacts with the authority to those which have a security dimension in order to prevent terrorism," an official quoted Israeli interim Prime Minister Ehud Olmert as telling Parliament's Defense and Foreign Affairs Committee.

But Olmert also said that Hamas is not a strategic threat to the Jewish state, signaling that Israel will continue to pressure the Palestinians through diplomatic - not military - action.

With U.S. President George W. Bush and some Western nations threatening to halt aid to a Hamas-controlled government, Iran pledged financial assistance to the cash-strapped authority.

"We will definitely help this government financially in order to resist America's cruelty to this country," Iran's Supreme National Security Council chief Ali Larijani told Hamas' overall leader Khaled Meshaal.

Larijani said the deal was meant to make up for threatened cuts in U.S. aid.

Israeli officials warned that a Hamas-led government would further isolate itself if it accepted Iranian aid.

"The incoming Palestinian leadership has to decide if it wants to be part of the legitimate international community or if it wants, through its own actions, to align itself with international pariahs," Foreign Ministry spokesman Mark Regev said.

He said Israel would be "entitled to use all legal means" to prevent the money from going to "support terrorism and to strengthen a terrorist leadership."

Arab League Secretary General Amr Moussa urged the EU to continue providing aid.

"The money given to government of Palestine does not go to ministers to enjoy their lives. It is for the Palestinians to eat, to send children to school," Moussa told the European Parliament's foreign affairs committee.

Moussa told lawmakers that the EU had to put aside animosities over the group's record and respect the fact that its political wing won elections in a democratic vote.

"Do you want to isolate Hamas or do you want to lure Hamas into your ranks as it were? Do you want to push Hamas or the new government to rigid positions or do you want an evolving position and stance?" He said that if the new Palestinian government chooses peace, then the EU, the Arab League and others "should make every effort to help this government."

The Salafist Movement, a Kuwaiti Islamist group, called on the emirate and other Arab and Muslim countries to boost financial aid to the Palestinians.