The move was immediately dismissed by Palestinian factions.
The government approved the release of prisoners with no "blood on their hands" in a 14-9 vote shortly before Sharon left to discuss the “road map” for peace with US President George W. Bush.
The release of members of Hamas and Islamic Jihad, both organisations that deny the right to existence of the Israeli state, was a move away from the Israeli government’s initial stance.
Sharon is trying to help unelected Palestinian Prime Minister Mahmoud Abbas, better known as Abu Mazen, deflect accusations from the two banned groups that he is making too many concessions for peace.
The Palestinian Authority gave out mixed signals over the decision.
"This measure is encouraging,” Palestinian information minister Nabil Amr told Agence France Press.
“It will be even more encouraging if Israel decides on more releases and if there is an agreement between Israeli and Palestinian ministers for these releases."
But Palestinian Minister for Prisoners told Aljazeera that the move was publicity stunt intended to reduce US pressure ahead of Sharon's visit.
"What has happened will not push forward the political process and secure the ceasefire...The decision will hinder the issue of prisoners and reduce the hope that all detainees will be released."
The Israeli army also removed a number of checkpoints in the West Bank.
The first car to travel the newly liberated road was cheered by a large crowd of Palestinians. It is the most significant concession yet since the launch of the “road map,” AFP said.
Both Islamic Jihad and Hamas spokesmen dismissed the Israeli move as diversionary.
“We reject this position and we do not consider it an initiative by the Israeli government,” Mohammed al-Hindi, an Islamic Jihad leader in the Gaza Strip told Reuters.
“It is like someone is trying to throw dust in our eyes,” he said.
Islamic Jihad and the larger Hamas want Israel to release some 7,000 Palestinian political prisoners before they will agree to support the implementation of the "road map".
Ismail Haniya, a senior Hamas leader, insisted his movement would not be satisfied until all prisoners were released.
This decision is not sufficient. All detainees must be released
unconditionally. If not, the Israeli occupation will be entirely responsible for the consequences," he warned.
Abbas' visit to Washington Friday marked the first visit of the Palestinian leader to the White House since he was imposed as prime minister at the insistence of the US.
The US president offered support, criticising Ariel Sharon’s construction of a "separation fence" in the West Bank.