The European Union today released a limited aid package to the Palestinians which it said would help to stave off a looming financial crisis.

The continuation of EU funding to the Palestinian Authority has been under debate since the Islamist militant group Hamas won elections and appointed a prime minister.

"Today I will announce a very substantial package of assistance to meet basic needs," said Benita Ferrero-Waldner, the European External Relations Commissioner.

She spoke as EU foreign ministers gathered for talks on how to respond to the impending formation of a Palestinian government by the movement, which does not recognise Israel’s right to exist.

The package would total €120 million euros (£82 million), including €40 million to pay electricity bills and €64 million channelled through the UN Relief and Works Agency for Palestinian refugees, she said.

"In effect we will pay electricity bills for them, direct to the utilities concerned, including in Israel," she said.

The EU is the largest donor to the Palestinian Authority, but its funding has been thrown into doubt by the election of Hamas, which the EU lists as a banned terrorist group.

The move comes after Israel stopped the monthly transfer of $50 million-$55 million (£29 million-£32 million) in tax payments to the Palestinians and US officials warned that Washington could cut off funding.

"The Palestinian Authority cannot achieve balance in its finances without outside help," Ms Ferrero-Waldner said, calling on others, especially Arab countries, to do more to fund it.

She noted that even when Israel transferred the tax revenues which it collects on behalf of the Palestinians, the Authority still runs a deficit.

The EU has also decided to unblock €17.5 million (£12 million) frozen in a World Bank-administered trust fund. The EU originally paid €70 million (£48 million) into this, of which €35 million (£24 million) was disbursed but the remainder stopped over the Palestinian Authority’s failure to meet certain benchmarks.

This €17.5 million (£12 million) tranche will be used to pay salaries, and is the only part of the new aid package announced today to be paid directly to the Palestinian Authority.

The Palestinians' financial troubles are growing acute. James Wolfensohn, an international envoy to the Middle East Quartet which is overseeing the peace process, gave warning in a letter released today that the Palestinian Authority is facing financial collapse within two weeks since Israel has cut off tax transfers in response to Hamas’s election victory.

Even if the Palestinian Authority survived with emergency funding, the financial crisis could bring violence and chaos unless the Quartet of major peace mediators developed a long-term funding plan once a Hamas-led government is in place, wrote Mr Wolfensohn in his letter, which the Reuters news agency has seen.

He was expected to brief the Quartet, made up of the United States, the EU, the UN and Russia, on his findings later this week.

In the letter, the Quartet’s special envoy said that the caretaker Palestinian government faces a funding gap of $100 million (£57 million) this month and up to $70 million (£40 million) in March, mainly because of Israel’s decision to withhold $50 million to $55 million (£29 million to £32 million) a month in tax revenue.

"Unless a solution is found, we may be facing the financial collapse of the PA (Palestinian Authority) within two weeks," Mr Wolfensohn wrote.

He said that the Palestinian Authority will need $60 million to $80 million (£34 million - £46 million) next week to begin to pay wages for February.

"I know I do not need to tell each of you that the failure to pay salaries may have wide-ranging consequences - not only for the Palestinian economy but also for security and stability for both the Palestinians and the Israelis," Mr Wolfensohn said.

But any money raised by Wolfensohn at the Quartet’s direction would tide the Palestinian Authority over only until the new Hamas-led cabinet is formed, most likely to happen next month.

The Quartet has yet to agree on what to do once Hamas takes over. There are differences of opinion in the mediating group over how to exert pressure on Hamas to renounce violence, recognise Israel and honour interim peace deals.

Times Recommends

• Michael Jackson: Not the final chapter
• Indian Army spends10m rupees on golf buggies
• Brüno toned down for 15 rating