President Mahmoud Abbas has told reporters that the agreement is based on the 'national reconciliation agreement' which implicitly recognises Israel’s right to exist.
But no specific details of the plan have been announced and Hamas spokesman Sami Abu Zuhri has told news agency AFP that signing up to the agreement doesn’t mean Hamas was recognising Israel.
Mr Abbas will dissolve the current government within the next 48 hours and charge the Hamas prime minister, Ismail Haniya, with forming a new cabinet.
"In the coming days, we will start the process of forming this new government and we appeal to our people to support our efforts," Mr Abbas told reporters in the Gaza Strip.
"President Abbas will be issuing a presidential decree within the next 48 hours to dismiss the current government and charge a new prime minister" to form a new cabinet, Mr Abbas’s spokesman Nabil Abu Rudeina said.
It’s now expected that 43 year- old Prime Minister Haniya has five weeks to form the new unity government. Hamas and Fatah will then have to agree on the makeup of the incoming cabinet to complete the process.
"This agreement was anticipated because the will was real and honest in the greater interest of the Palestinian people and to strengthen national unity and to protect (Palestinian) rights and principles." Mr Haniya said.
The Palestinian territories have been gripped by a financial crisis since Hamas swept to power in elections earlier this year, with Western countries freezing direct assistance and demanding that Hamas renounce violence and recognise Israel’s right to exist.
Muted reaction
Initial international reaction to the agreement was cautiously hopeful. British Prime Minister Tony Blair welcomed the announcement.
"Of course, we have to see the details, but potentially, and I stress, potentially, this is a highly significant announcement, and we will want to see the details and how this unfolds over the coming days," a spokesman for Mr Blair said.
The European Union hoped it would re-energise the peace process, "I welcome the statement made today by the Palestinian President Mahmud Abbas. I hope that he will succeed very soon in his efforts to form a unity government," EU foreign policy chief Javier Solana said in a statement.
While Israel gave a guarded welcome, with Foreign ministry spokesman Mark Regev saying that provided the new government recognises Israel's right to exist, renounces violence and accepts previous peace agreements, and also gets soldier kidnapped by militants free, the stalled Middle East peace process could resume.
"This would give very positive momentum and re-energise the Israeli-Palestinian dialogue and put the peace process back on track," Mr Regev said.
But he added that "Anything short of that would lead to more stagnation that is not in Israel's interest nor in the Palestinians' interest."
Strike
The aid freeze has plunged the Palestinian territories into an economic crisis, with more than 160,000 civil servants not paid, in full, for six months. Many civil servants have gone on strike to protest their conditions.
Following the announcement of the unity government, Mr Abbas called on those striking to go back to work.
"We call for a return to work and the end of the strike because all the sons of the Palestinian people should unite together in the national interest," Mr Abbas said.
But the main Palestinian public sector unions rejected the call, "The strike will remain in place until our demands are met," Bassam Zakarna, chairman of the public sector employees' union, told a news conference.
"This strike is not connected to the type of government and it will continue because what matters to us is the payment of our salaries," he added.
The strike has paralysed the public sector and put back the start of the new school year, originally scheduled for September the second. Hamas has accused Fatah officials of orchestrating the strike in order to put pressure on the organisation.