The European Union was set to release substantial aid to the Palestinians yesterday to stave off imminent financial collapse, despite the appointment of a leader of the Islamist militant group Hamas as prime minister.

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

She spoke as EU foreign ministers met to discuss how to respond to the impending formation of a Palestinian government by Hamas, which does not recognise Israel's right to exist and espouses armed struggle.

The package totals 120 million euros ($142 million), including 40 million euros to pay energy bills and 64 million euros channelled through the U.N. Relief and Works Agency for Palestinian refugees (UNRWA).

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

The move came amid intense debate among major powers on how to react to Hamas's election victory.

International envoy James Wolfensohn warned in a confidential letter obtained by Reuters that without emergency funds, the Palestinian Authority faced financial collapse within two weeks now that Israel has cut off tax transfers.

The EU is the largest donor to the Palestinians, but its funding has been thrown into doubt by the ascendancy of Hamas, which the 25-nation bloc lists as a banned terrorist group.

Israel has stopped the monthly transfer of $50-$55 million in tax payments to the Palestinians, and the United States has demanded the return of $50 million in aid to prevent it falling into Hamas's hands.

Wolfensohn said that even if the PA survived with emergency funding, the financial crisis could bring violence and chaos the Quartet of international mediators -- the United States, the EU, Russia and the United Nations -- developed a long-term funding plan once a Hamas-led government is in place.

His letter to foreign ministers of the Quartet, obtained by Reuters in Jerusalem, was dated Feb. 25 and apparently timed to influence the EU deliberation.

Ferrero-Waldner noted that even when Israel transferred the tax revenues which it collects on behalf of the Palestinians, the authority still runs a deficit.

?The Palestinian Authority cannot achieve balance in its finances without outside help?, she said, calling on others, especially Arab countries, to do more to fund it.

Hamas has named Ismail Haniyeh as Prime Minister designate. Ferrero-Waldner said the EU had yet to decide whether it would support his government.

"We have to see what will be the programme of the government. We have to give them time," she said.

She added that the bloc would seek to work with Palestinian President Mahmoud Abbas, regarded as a moderate, saying the EU's current aim was "supporting the caretaker government and trying to do everything to give Mahmoud Abbas our full support".

Hamas said the EU should not wait to see the make-up of the new government but start supporting it straight away.

"In Hamas, we are awaiting to see a positive position from the European Union over the support to the Palestinian people, who chose Hamas to represent them and to form the coming government," Hamas political leader Khalil Abu Laila told Reuters.

"The European Union should respect the choice of the Palestinian people and provide the necessary assistance to the government that will be led by Hamas and its prime minister-designate Ismail Haniyeh," he said.

The EU has also decided to unblock 17.5 million euros frozen in a World Bank-administered trust fund. The bloc originally paid 70 million euros into this, of which 35 million was disbursed but the remainder stopped over the Palestinian Authority's failure to meet certain benchmarks.

This 17.5 million euro tranche will be used to pay salaries and is the only part of the new aid package announced on Monday to be paid directly to the Palestinian Authority.

EU foreign policy chief Javier Solana reiterated the bloc's determination to keep the Palestinian Authority afloat.

"We'll not let the Palestinian people down," he said, adding that the Authority should remain solvent for another month: "There will be enough resources to maintain it at least until the end of March." (Additional reporting by Ingrid Melander in Brussels and Adam Entous in Jerusalem) ($1=.8441 Euro)