Israel froze $88 million in Palestinian funds Sunday, elevating tensions over an Egyptian initiative to broker a power-sharing agreement between Hamas and the Palestinian Authority and raising new concerns about the prospects for peace in the region.

Meanwhile, Egypt's foreign minister urged a visiting U.S. congressman to press Congress and the Obama administration to recognize a Palestinian state. The move follows the Muslim Brotherhood's announcement Saturday that it will increase the number of seats for which the Islamist organization plans to field candidates in Egypt's parliamentary elections scheduled for September.

Egypt's new foreign-policy forays show how the country is adjusting policies to reflect popular opinion more closely in the wake of President Hosni Mubarak's resignation, while at the same time threatening to profoundly alter relations with the Jewish state.

Israel's move, which followed months of watching nervously from the sidelines, could imperil its security cooperation with the Palestinian Authority, which is dominated by Fatah, the other Palestinian faction. That cooperation has helped limit violence in the West Bank in recent years.

Hamas leader Khaled Meshal arrived in Cairo Sunday, two days after the initiative was announced, to finalize negotiations, Egypt's MENA news agency reported.

That same day, Israeli Finance Minister Yuval Steinitz froze $88 million in Palestinian customs revenue due to be passed along to the Palestinian Authority.

Privately, U.S. and Middle East diplomats say the latest developments raise concerns in Washington and European capitals about Mideast peace and Egypt's foreign policy.

President Barack Obama and Israeli Prime Minister Benjamin Netanyahu were both expected to give speeches in coming weeks announcing new initiatives to jump-start stalled peace talks between the Israelis and Palestinians. Mr. Netanyahu's address is scheduled take place before Congress later this month. But now, officials in the U.S. and Israel, both of which label Hamas a terrorist group, acknowledge these speeches might either be delayed or significantly watered down.

"What's Netanyahu going to say with Hamas now in the government," said an official involved in the deliberations. "He's going to feel he can't give ground."

The renewed push toward Palestinian unification constitutes the first tangible regional diplomatic achievement by the Egyptian government in the post-Mubarak era. It brokered the accord without informing the U.S. and Israel, a departure from Mr. Mubarak's close coordination when dealing with Hamas.

It follows a series of Egyptian initiatives that have raised anxieties in Israel. Almost immediately after Mr. Mubarak's resignation, the new government legalized the long-banned Muslim Brotherhood, which has launched its own political wing.

Meanwhile, Egypt recently announced it will re-establish diplomatic ties with Iran. While the government said it wasn't embracing Iran or endorsing its policies, the move was the first sign of an independent streak in the new government, leaving Israel and the U.S. uneasy and unsure over how to react.

And on Sunday, Egypt's Foreign Ministry said the country intends to permanently open its border with Gaza.

But the move to help unite the Palestinian factions is what pushed Israeli officials into announcing they would withhold Palestinian funds.

Fatah has fought bitterly with Hamas, which is supported by Iran. Yet both sides have acknowledged the need for a unified Palestinian government if the Palestinians are going to push for recognition in the United Nations later this year, as they have promised. On Sunday, Egypt's foreign minister, Nabil Al Araby, urged Rep. Steve Chabot (R., Ohio), to press Congress and the Obama administration to recognize a Palestinian state.

Israel and the U.S. believe a Palestinian state must be recognized only through negotiations between Israel and a Palestinian government that doesn't involve Hamas, at least until it renounces violence and recognizes Israel's right to exist.

"We've said repeatedly that final-status issues can only be resolved in direct talks between the parties and not in the U.N. Security Council," said a senior U.S. official.

Israel collects some tax and customs fees for the Palestinian Authority under peace agreements of the 1990s. Israel has held up and then ultimately released cash transfers several times in the past decade, citing concerns that the money was being used to fund attacks against Israelis.

"I think the burden of proof is on the Palestinians, to make it certain, to give us guarantees, that money delivered by Israel is not going to the Hamas, is not going to a terrorist organization, is not going to finance terror operations against Israeli citizens," Mr. Steinitz said.

Israel may be reacting to more than just the new push for Palestinian unity. The Jewish state is carefully watching Syria, where growing unrest threatens to envelop a northern neighbor with which Israel is still technically at war over a strip of territory known as the Golan Heights.

Israelis worry that Syria's regime or its ally, the Iranian-backed militant group Hezbollah in neighboring Lebanon, could lash out at Israel to try to unite restive citizens of Arab countries behind a common enemy.

Yet the Egyptian political drift toward greater domestic tolerance of Islamist groups and support for the Palestinians, including a new willingness to work with Hamas, has Israel most worried. The trends could come to a head in September, when Egypt is planning its first post-Mubarak parliamentary elections and the Palestinians are expected to press for state recognition at the U.N.

"The situation in Egypt is deteriorating," said a senior Arab official. "And it could grow more unpredictable as the country moves toward elections."

Those elections are likely to showcase the political prowess of the Muslim Brotherhood in the new Egypt, where the group's true popularity remains untested in free elections.

The Brotherhood, seeking to ease fears it would seek to dominate the government, has kept a very low profile. It says, for example, it won't run a candidate for president.

The decision to field more candidates may be a sign of the organization's increasing confidence in the Egyptian public's appetite for political Islam following generations of largely secular, one-party rule.

But the move is also an indication of the group's fitness as a political organization compared to its competitors. The Brotherhood remains one of the only experienced, organized and powerful political parties in postrevolutionary Egypt.