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By Paul Taylor and Ingrid Melander

BREMEN, Germany, March 31 (Reuters) - European Union foreign ministers hailed an Arab peace initiative for the Middle East on Saturday and agreed to engage with non-Hamas members of the new Palestinian national unity government.

The ministers said they would seek ways of redirecting aid to the Palestinians towards institution-building and economic development in talks with Finance Minister Salam Fayyad. But they warned against expecting an overnight resumption of direct assistance to the Palestinian Authority.

The EU voiced full support for the plan revived at an Arab summit in Riyadh this week offering Israel peace and relations in exchange for complete withdrawal from Arab land occupied in 1967 and a solution to the Palestinian refugee problem.

"The Arab peace initiative and also the somewhat positive reaction from (Israeli) Prime Minister (Ehud) Olmert are very good things," European External Relations Commissioner Benita Ferrero-Waldner told reporters.

"The international community should not lose that opportunity (for peace). We have already lost many opportunities," Spanish Foreign Minister Miguel Angel Moratinos told reporters after the EU ministers discussed the Middle East.

The 27-nation EU boycotted the Hamas-led government formed last year because it refused to recognise Israel, renounce violence of accept past peace accords.

The unity government formed this month between President Mahmoud Abbas' moderate nationalist Fatah party and Hamas agreed to respect past agreements, but Hamas insisted it would not recognise the Jewish state or renounce armed resistance.

"We have a pragmatic position to deal with all interlocutors that are not members of Hamas," Moratinos said, mentioning the Palestinian finance, interior and foreign ministers.

Ferrero-Waldner has invited Fayyad, a respected independent technocrat, to Brussels on April 11 to discuss ways of channelling aid to the Palestinians.

AID TALKS

She and German Foreign Minister Frank-Walter Steinmeier said a temporary mechanism to distribute aid bypassing the government would have to remain in place for a while longer.

"We will continue to rely on the temporary financing mechanism until we can evaluate the new government and the possibilities of the new finance minister," Steinmeier told a news conference.

Talking about the "profound disorder in the Palestinian finances," Swedish Foreign Minister Carl Bildt said it would take Fayyad months to be ready to receive aid.

Ferrero-Waldner briefed the ministers on proposals to shift more assistance from monthly subsistence allowances for 150,000 families to rebuilding structures that could help economic recovery and prepare for a Palestinian state.

EU officials said the ministers agreed the bloc would press for cooperation between the Quartet of international mediators grouping the United States, the EU, Russia and the United Nations, and a newly-formed Arab Quartet formed by Saudi Arabia, Egypt, Jordan and the United Arab Emirates.

German Chancellor Angela Merkel, who left on Saturday on a three-day trip to Lebanon, Jordan, Israel and the Palestinian territories, was downbeat on prospects for early progress.

"Now we must see how much movement we can get from this for the peace process in the Middle East. Although I think there is a very long, hard stretch ahead of us," she said in Berlin.

Palestinian Foreign Minister Ziad Abu Amr, another political independent, will visit Paris next week. (Additional reporting by Tom Armitage in Berlin and Louis Charbonneau and David Brunnstrom in Bremen)

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