Israel on Sunday approved the release of 170 Palestinian prisoners in a goodwill gesture toward Egypt and the new Palestinian leadership, officials said, but a Palestinian official dismissed the Israeli move as "cosmetic."

News of the prisoner release came hours after Israel ended a two-day military operation in the southern Gaza Strip, leaving dozens of Palestinian homes in rubble.

The prisoner release, which comes ahead of the Jan. 9 Palestinian presidential election, was part of a deal with Egypt this month that brought home an Israeli jailed by Cairo on espionage charges.

Prime Minister Ariel Sharon called Sunday's decision by a ministerial committee a "goodwill gesture" and spoke of "deep friendship" for Egyptian President Hosni Mubarak.

A senior Israeli official said the move was also aimed at interim Palestinian leader Mahmoud Abbas, who is seeking election in the Jan. 9 presidential vote.

"It gives them an indication that we want to have an atmosphere of reconciliation," the official said, speaking on condition of anonymity. He said Israel would consider further releases if the Palestinians take action against militants.

Israel tacitly supports Abbas in the election, viewing him as a moderate pragmatist. Abbas has made releasing prisoners a priority and Israel's move could boost Abbas' standing.

Israel holds an estimated 7,000 Palestinian prisoners, many accused of security-related crimes. Sharon's office said prisoners actively involved in attacks on Israelis would not be released. The prisoners are to be freed next week, it said.

Palestinian officials, who have long demanded the release of all prisoners, gave Sunday's announcement a cool reception.

"We consider this step a cosmetic one. We have not been consulted about this release," said Radi Jaraie, the deputy Palestinian minister of prisoner affairs.

In Gaza, Israeli troops withdrew from the Khan Younis refugee camp late Saturday, ending a two-day operation that killed 11 Palestinians and wounded dozens more. The operation reduced nearly 40 homes to rubble, U.N. officials said.

Residents awoke Sunday to piles of broken furniture, clothing and household goods strewn throughout the destruction. Men used shovels to salvage belongings, while children stood watching, schoolbags on their backs.

"What can we do, and where can we go? They left us nothing," said Amena Tratori, a 44-year-old mother of six, looking at the mound of rubble that was once her home.

"If they (the Israelis) think that by killing people and destroying their homes they can stop resistance, they are mistaken. The young children will remember the destruction and will never forget."

The raid followed some 50 Palestinian mortar and rocket attacks that killed a Thai worker in a Jewish settlement and injured 17 other people, including 11 soldiers, the army said, adding that it targeted houses militants used as launch pads.

Early Sunday, Palestinian militants in northern Gaza fired three homemade rockets into southern Israel, lightly wounding two people in Sderot, the army said. Hours later, Israeli aircraft struck a rocket launcher and mortar launcher in northern Gaza, the army said.

The army also reported new mortar fire on settlements in southern Gaza.

Also Sunday, Sharon's Likud Party and the opposition Labor Party appeared ready to finalize a pact to form a coalition government, an alliance that would bolster Sharon's plans to withdraw from the Gaza Strip and four small West Bank settlements next year.

Israeli media reported the deal would be signed as soon as Sunday, and the new Cabinet ministers could be sworn in next week.

Israeli and Palestinian officials were to meet later Sunday to discuss preparations for the Jan. 9 vote. Israel has pledged to remove troops from Palestinian areas and take other measures to ensure a smooth election.

More than 40 European Union election observers were dispatched throughout the West Bank early Sunday to begin preparations for the election. The EU is to send more than 260 observers. Some 300 Palestinians in the West Bank and Gaza Strip also began training Sunday to assist the observers.