Israel removed metal detectors placed at the entrance of a holy site in Jerusalem's Old City in the early hours of Tuesday after the new security measures set off deadly violence.
The cabinet said the metal detectors - installed at entry points to Al Aqsa mosque compound after two police officers were fatally shot on July 14 - will be replaced by smart, less obtrusive surveillance means.
The move came after intensive international diplomacy seeking to stop the outbreak of wider unrest, with warnings that it could spread far beyond Israel and the Palestinian territories.
A worker was seen in the early hours of Tuesday removing the metal detectors at one entrance. Muslim officials said all had been dismantled.
Israel's security cabinet accepted "the recommendation of all the security bodies to change the inspection with metal detectors to a security inspection based on advanced technologies and other means", prime minister Benjamin Netanyahu's office said.
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As word spread of the decision, a few hundred Palestinians gathered to celebrate near an entrance to the Haram Al Sharif mosque compound, known to Jews as the Temple Mount.
One person set off a firework, prompting Israeli police to raid and disperse them using sound grenades.
The spike in tensions and the deaths of three Israelis and four Palestinians in violence on Friday and Saturday have triggered international alarm and prompted the United Nations Security Council to convene a meeting to seek ways of calming the situation.
It was not clear what type of of advanced technologies the cabinet spoke of would be used, though cameras were installed at entrances to the site this week. The cabinet added that it had allocated 100 million shekels (Dh103m) for the equipment and for additional police officers.
It was also not clear whether they would be accepted by Muslim worshippers.
"This movement is a movement of the street," said Sheikh Raed Dana of the Islamic Waqf organisation, which administers the holy compound.
"We as the Waqf listen to the street. The street says yes and we say yes; if the street says no to the measures, we will say no."
Israel installed metal detectors at entrances to the site, which includes the Al-Aqsa mosque and the Dome of the Rock, after an attack on July 14 that killed two policemen.
Palestinians viewed the new security measures as Israel asserting further control over the site. They refused to enter the compound in protest and prayed in the streets outside instead.
Israeli authorities said the metal detectors were needed because the July 14 attackers smuggled guns into the site and emerged from it to shoot the officers.
Clashes have broken out during protests over the measures, leaving five Palestinians dead.
Three Israelis were also killed when a Palestinian sneaked into a house in a West Bank settlement and stabbed them.
The decision to remove the metal detectors follows talks between Mr Netanyahu and Jordan's King Abdullah II. Jordan is the official custodian of Muslim holy sites in Jerusalem.
It also comes after one of US president Donald Trump's top aides, Jason Greenblatt, arrived in Israel for talks over the crisis and with the UN Middle East envoy warning of a further escalation.
"It is extremely important that a solution to the current crisis be found by Friday this week," the envoy, Nickolay Mladenov, said after briefing the UN Security Council, which met to discuss how to defuse the tension on Monday.
"The dangers on the ground will escalate if we go through another cycle of Friday prayer without a resolution to this current crisis," he said, warning that violence there could spread "beyond the Middle East itself".