Israel and the Palestinian Authority say they have made significant progress at talks about pulling Israeli forces back from the Gaza Strip and Bethlehem.
The Palestinians are getting ready to police their own land
Israeli Foreign Minister Silvan Shalom said after the US-brokered talks in Tel Aviv that an agreement was "close" while Palestinian sources said the main stumbling block to progress had been removed.
The reported progress came as three suspected Palestinian militants and a civilian were killed along with one Israeli soldier in an operation against Hamas in Gaza City.
In other developments the European Union shrugged off US calls to outlaw the political wing of the militant organisation on Friday.
You can't say that the whole of Hamas is a terrorist
organisation and certainly that is not our position
European Commission spokesman
Under the US-backed peace plan known as the roadmap, Israel is due to withdraw to positions it held before the outbreak of fighting in September 2000.
BBC Middle East analyst Roger Hardy says the expected withdrawal is being timed for the arrival of US national security adviser Condoleezza Rice in the region.
A Hamas leader, Abdel-Aziz al-Rantissi, told the BBC on Friday that the group was not ready to declare a formal ceasefire despite widespread anticipation.
He appeared to contradict remarks earlier in the day by the group's spiritual leader, Sheikh Yassin, who was quoted as saying that Hamas
had decided to observe a truce and suspend its combat operations against Israel.
Raid on Hamas
Israeli soldiers swooped on Gaza City's Moraka suburb early on Friday apparently after a tip-off that militants were planning an imminent attack in the area.
As they approached the house of leading Hamas militant Adnan al-Ghoul, a bomb exploded wounding one Israeli soldier and a gun battle erupted, witnesses said.
Backed by tanks and helicopter gunships, the soldiers finally surrounded the house and laid explosives, reducing it to rubble, Palestinian sources said.
Israel's pursuit of Hamas continues
The Palestinians named the dead as the son and the nephew of Mr al-Ghoul as well as an Islamic Jihad gunman who was reportedly shot dead outside the house.
Adnan al-Ghoul was not in the house during the attack, Palestinian and Israeli sources confirmed. The troops also wounded and arrested one suspected Hamas member.
Palestinian medical sources said a 30-year-old man unconnected to militants was also killed in the fighting which reportedly went on for two hours.
The Israeli army confirmed that one of its men, a sergeant, was killed in the operation in addition to the soldier wounded.
Israeli media also said a Hamas leader based in Jenin, in the West Bank, was arrested overnight by Israeli troops.
EU resists ban
In Brussels, the chief spokesman for the European Commission's executive committee, Reijo
Kemppinen, seemed to brush off a call by President Bush this week to extend the EU's ban on Hamas's military wing to the organisation completely.
Direct US involvement is a new element
"You can't say that the whole of Hamas is a terrorist
organisation and certainly that is not our position," Mr Kemppinen said.
He cited Hamas's welfare programmes in the Palestinian territories.
Condoleezza Rice's visit this weekend is a new step in direct US involvement in Middle East peace negotiations:
President George W Bush visited the region in early June, proclaiming that Middle East peace was his highest priority now that Saddam Hussein had been ousted in Iraq
Secretary of State Colin Powell visited last week to urge the sides to stick to the roadmap
US Ambassador to Israel Dan Kurtzer and US peace monitor John Wolf brokered the latest Palestinian-Israeli talks at the US Embassy in Tel Aviv
While Ms Rice's visit may coincide with an Israeli troop withdrawal from Gaza and Bethlehem, the Americans view the possibility of a militant ceasefire with indifference bordering on contempt, our analyst says.
Washington's blunt message - which is causing some discomfort in Europe as well as the Arab world - is that Hamas has no political role to play and must be destroyed.