EU foreign ministers have endorsed a temporary halt to direct aid to the Palestinian government led by Hamas.
Supporters of Hamas joined a protest in Gaza against the aid cuts
The EU says it cannot fund the organisation unless it renounces violence, recognises Israel and commits to past peace agreements.
Hamas, which won elections in January, is described as a terrorist group by the EU and the United States.
The EU, the biggest aid donor to the Palestinians, is expected to maintain some humanitarian aid.
The EU's External Relations Commissioner, Benita Ferrero-Waldner, said she supported the European Commission's proposal which was backed by foreign ministers.
"But at the same time, of course, we will want to stand by the Palestinian people as we always said and we'll want to help them with their basic needs, that means water, electricity, that means maybe education, that means food aid," she said.
The Palestinian Authority (PA) has received about $600m (500m euros; £340m) a year in aid from the EU since its foundation in 1994, with another $400m coming from the US.
The US said it would suspend or cancel direct aid, although it would boost humanitarian aid to Palestinians through United Nations aid agencies.
The European Commission said last week that the suspension of direct aid from the EU would mean $36.9m (30m euros; £21m) was at stake in the immediate future.
Hamas is complaining of international blackmail, and supporters joined protests outside the building where EU representatives are based in Gaza City.
BBC Arab affairs analyst Magdi Abdelhadi says both the EU and the US have been looking into ways to channel money into Palestinian society, possibly through the UN or aid agencies, to keep basic services running.
Otherwise, he says, there is a real risk of more anarchy and chaos in the Gaza Strip and the West Bank - something that no one wants to see happening.