Palestinian leader Mahmoud Abbas has said a deal has been struck with the militant group Hamas on the programme of a national unity government.
The key details of the deal between Haniya and Abbas are unknown
Hamas confirmed the agreement, though its details are unclear.
Palestinians are hoping that a national unity government will open the way for international aid donors to end their boycott of the Palestinian authority.
Mr Abbas is expected to dissolve the Hamas led-government within the next 48 hours, his spokesman has said.
All the signs are that Ismail Haniya, the current prime minister from Hamas, will be asked by Mr Abbas to form the next Palestinian government.
Talks between the two men on a unity government have been going on for months.
During a visit to the West Bank on Sunday, UK Prime Minister Tony Blair said a unity government that recognised Israel would allow donors to end the crippling aid boycott.
Hamas wants a unity government, but has rejected the UK proposal.
A spokesman for the group reiterated its position on recognising Israel on Monday.
"Hamas will continue to have its political agenda... we will never recognise the legitimacy of the occupation," Sami Abu Zuhri said.
Whether the international community lifts the aid embargo on the Palestinian Authority is likely to depend on the details of the Hamas-Fatah deal.
The key issues are a Hamas renunciation of violence, recognition of Israel and acceptance by Hamas of peace agreements signed by Israel and the Palestinians.
The international aid boycott on the Palestinian Authority was imposed after Hamas came to power earlier this year because of the group's refusal to renounce violence or recognise Israel.
The aid embargo has crippled the authority, which has been unable to pay its tens of thousands of employees.
In the Gaza Strip, living conditions for Palestinians have reached breaking point, the UN warned recently.
Israel has kept Gaza's borders largely sealed for months and conducts regular military operations, prompted in part by the capture of an Israeli soldier.
Mr Blair's meetings with Mr Abbas and with Israeli Prime Minister Ehud Olmert appear to have brought the prospect of talks between the two men closer - both said they were ready for talks without pre-conditions.
However, Israeli Foreign Minister Tzipi Livni told Israeli TV on Sunday that talks based on the internationally backed roadmap regional peace plan were out of the question as long as Hamas remained committed to violence.
Monday saw Israeli forces shoot dead a Palestinian man and wound two others near the West Bank town of Jenin, Palestinian doctors said.
Witnesses said the troops opened fire on a car travelling from the village of Roumane, killing the head of the local village council.
Israel radio reported that the army had detained 13 militants in several parts of the West Bank.
On Sunday, Palestinians said a teenager was killed and another wounded when an Israeli tank fired a shell in southern Gaza. The Israeli military said soldiers fired at Palestinians suspected of planting a bomb.