The Israeli army has ended a six-day siege of Tel Sultan in the Gaza Strip.
The UN estimates at least 1,600 people have lost their homes
Troops first moved in the area last Tuesday in Operation Rainbow, which Israel said was to destroy tunnels used for arms smuggling from Egypt.
Subsequent fighting left more than 40 Palestinians dead, and dozens of houses were demolished.
A military source said the redeployment was to "ease conditions for Palestinians", although Israeli troops remain in nearby Rafah.
Operation Rainbow is part of preparations for a pullout from the area envisaged by Israeli Prime Minister Ariel Sharon.
The original proposals were rejected by his Likud party and a revised plan will be presented to the cabinet in a week's time.
The new formula reportedly calls for a withdrawal from the Gaza Strip and four West Bank settlements in stages, instead of all at once.
About six Israeli tanks, which had been stationed at the entrance to Tel Sultan, withdrew in the early hours of Monday, leaving residents free to go out in the streets.
Local Muslim clerics say there are 17 bodies awaiting burial in morgues in nearby Rafah. Relatives have been unable to hold funerals because of military restrictions.
"Two are in the hospital (morgue) and 15 were stored in a
local refrigerator once used for storing potatoes and
flowers," said Rafah hospital director Dr Ali Mousa.
As well as burying their dead, residents will now be able to buy food, water and medicines.
However, the Israeli army is still holding another neighbouring area, the Brazil camp.
Rafah's residents have been angered by the scale of destruction caused by the past week's operation.
Dozens of homes were demolished and streets were torn up during the operation. Even the local zoo was left in ruins - the animals died or escaped.