Israeli Prime Minister Ehud Olmert says he plans to release 250 jailed members of the Fatah movement led by Palestinian leader Mahmoud Abbas.
Israel has already decided to unfreeze Palestinian funds
He announced the "goodwill gesture" at a summit in Egypt, attended by Mr Abbas and the leaders of Egypt and Jordan.
The meeting was aimed at boosting Mr Abbas and isolating his rivals, Hamas, after their takeover of Gaza.
Earlier, the Hamas captors of Israeli soldier Gilad Shalit broadcast what they say is his first audio message.
The voice on the tape says his health is worsening and he needs medical help.
The meeting in Sharm el-Sheikh brought together Mr Olmert, Mr Abbas, Egyptian President Hosni Mubarak and King Abdullah of Jordan.
Mr Olmert told the gathering: "As a gesture of goodwill towards the Palestinians, I will bring before the Israeli cabinet a proposal to free 250 Fatah prisoners who do not have blood on their hands."
He added that those freed would have to sign a commitment not to return to violence.
About 10,000 Palestinian prisoners are being held in Israeli jails, some without charge.
Mr Olmert also said he would make all efforts to secure the release of Cpl Shalit.
The sacked Prime Minister, Ismail Haniya of Hamas, said he was ready to engage in talks with Fatah.
A spokesman for Mr Haniya in Gaza said Hamas was "disposed to immediately take up this dialogue" urged by Mr Mubarak.
The Egyptian leader had earlier called for a "resumption of dialogue between all the children of Palestine, and the achievement of a common position that speaks for its people and its cause".
Hamas leaders have criticised the Egypt talks
For his part, Mr Abbas urged Israel to "start serious political negotiations, according to an agreed timeframe, with the aim of setting up an independent Palestinian state.
"My hand is stretched to the Israeli people," he said.
The Israeli leader only said that his ambition was to arrive at such talks.
He said an opportunity had been created to move forward with the peace process.
"I don't plan to let this opportunity slip away," he said.
On Sunday the Israeli cabinet decided to release the frozen tax funds to the Palestinian emergency government based in the West Bank.
The money - some hundreds of millions of dollars - was originally withheld by Israel after Hamas came to power in the January 2006 election.
Hamas - which was not invited to the summit - has strongly criticised the meeting.
Although Mr Abbas may have received much of the support he was seeking, it may not make any difference on the ground says the BBC's Heba Saleh at the summit.
Hamas is still in control of Gaza and that undermines any serious prospect of peace talks, says our correspondent.