The newspaper said the Egyptian-brokered agreement is part of a "new US initiative that includes Egyptian and and Syrian pressure on Hamas, internal Palestinian reconciliation and Israel's opening of the Gaza crossings".

But while Western diplomats confirmed that Cairo mediators were working on a package of measures, Israeli officials played down the reports that a deal with Hamas was close.

Defence Minister Ehud Barak denied a deal was imminent - although European and even Arab officials insist there is much going on behind the scenes.

Diplomatic sources said the new initiative would go beyond a straight prisoner exchange and would seek a formal ceasefire between Israel and Hamas, a gradual removal of Israel's blockade on Gaza and reconciliation between rivals Hamas and Fatah.

"The Egyptians are behind the package deal which is expected to speak about the truce, to speak about opening all the crossings to the Gaza Strip and to speak about Shalit," said Aziz Dweik, a prominent Hamas figure who is speaker of the Palestinian parliament and who was released last week from an Israeli prison.

The Ha'aretz report was backed up by the London-based Asharq Alawsat which reported that "significant progress" had been made in negotiations to free Shalit, who has been held by Hamas in the Gaza Strip for more than three years.

The paper said that Israel and Hamas reached a compromise according to which Israel would eventually release 1,100 Palestinian prisoners, of whom 400 would be picked by Hamas.

Israel would also end the Gaza Strip siege and open the Rafah crossing.

According to the media report, the first batch of Palestinian prisoners would be freed in the first stage of the deal. Shalit would then be transferred to Egyptian Intelligence.

The second stage would entail the release of all Hamas politicians held by Israel, at which point Shalit's parents would be allowed to see him in Cairo.

The third stage would see Israel release the remaining prisoners - and Shalit's homecoming.