Israel has decided to allow Palestinian residents of occupied East Jerusalem to vote in the 25 January elections, the Israeli defence minister has said.
Israel has softened its curbs on campaigning in East Jerusalem
A final decision will be taken at the weekly Israeli cabinet meeting to be held on Sunday.
The government had threatened to stop voting there, in protest at the participation of militant group Hamas.
Palestinian leader Mahmoud Abbas has threatened to delay the election if a free vote was prevented.
He said on Monday that US President George W Bush had given him a personal assurance that Palestinian residents would be able to vote.
Israel has occupied East Jerusalem since 1967. It has annexed the area and sees it as its exclusive domain.
Under international law the area is considered to be occupied territory.
The area is often called Arab East Jerusalem because the majority of its residents are Palestinian, and Palestinians hope to make it their future capital.
On Tuesday, Mr Mofaz told reporters that the vote would go ahead.
"Israel will follow the same policy as in the 1996 elections, which means it will allow people to vote in five post offices in East Jerusalem," he said.
But later, Acting Israeli Prime Minister Ehud Olmert told the US Secretary of State, Condoleezza Rice, that the final decision had not yet been made.
"The acting prime minister said that he will put the question of the participation of East Jerusalem before the cabinet on Sunday," a statement from the prime minister's office said.
Israel claims the whole city as its capital, but the Palestinians insist East Jerusalem must be the capital of any future Palestinian state.
The Secretary General of the Palestinian Council of Ministers, Samir Hulaila, told the BBC he hoped the Israeli decision would mean Palestinian residents would have access to the democratic process in full.
He added that he hoped that Israel would allow them to take part in the election as Palestinians, not as immigrants in a foreign country.
Scheduled for 25 January; originally set for July 2005
132 members elected to Palestinian Legislative Council (PLC)
Fatah and Hamas are main contenders
First time Hamas participates in parliamentary poll
Israel says Hamas cannot take part under a 1995 agreement
Last parliamentary elections held in 1996
The chief Palestinian negotiator, Saeb Erekat, said it was crucial the elections took place on time, and urged Israel not to put any obstacles in their way.
Doing so, he said, would not serve Israel's interests.
Mr Mofaz's announcement came as the US Assistant Secretary of State David Welch and Deputy National Security Adviser Elliott Abrams were visiting the region.
They had postponed their trip until this week after Israeli Prime Minister Ariel Sharon suffered a stroke.
US state department spokesman Sean McCormack said on Monday that the two men would discuss the election with both the Israeli and Palestinian governments.
The BBC's Keith Adams in Jerusalem says the question of whether voting would be allowed in East Jerusalem in this month's Palestinian election had dominated preparations for the poll.
Last week, Israeli police stopped Palestinian candidates from campaigning in the area.
Israel then announced candidates could campaign, but only after registering with police - and that supporters of Hamas would not receive permission.
But Palestinian politicians rejected the conditions, and Hamas said it had already started campaigning there.
The Islamist militant group is making a strong challenge to President Abbas' Fatah movement, and polls suggest it could win up to a third of the vote.