The compromise came just days after President George W Bush vetoed an expansion of such work in the US in a move that won praise from churches and anti-abortion campaigners.
Germany had led a coalition of eight countries that sought to bar any European public funding for human stem-cell research.
The deal paved the way for the adoption of the 25-nation bloc's A$94 billion, seven-year science program aimed at narrowing the research gap with the US and spurring economic growth.
EU president Finland said the compromise would ban allocating EU cash for research that involves destroying human embryos, including for the procurement of stem cells.
Extracting the human embryonic stem cells entails destroying the embryo, a step churches and some ethics campaigners say is tantamount to murder.
But ministers agreed after hours of haggling that the EU could fund research into "subsequent steps" involving human embryonic stem cells.
Scientists say research is needed to tackle diabetes and diseases such as Alzheimer's and Parkinson's.
"We took a little bit of a risk when we decided to organise this extraordinary meeting today but I am pleased to say that risk paid off," Finnish Industry Minister Mauri Pekkarinen said.
Most EU countries, including France, Portugal, Spain, Belgium, Sweden and Britain, support such research.
"We must avoid a situation where our scientists emigrate to other countries," Portuguese Minister Jose Mariano Gago said.
No country should be allowed to stand in the way of other countries who want to allow the use of human embryonic stem cells in research, Mr Gago said.
Stem cells can turn themselves into any other type of cell in the body, and can be taken from embryos or adults to develop drugs or repair parts of the body.