The decision followed similar steps in recent months by France, Spain, Portugal and Ireland. It was seen as a boost to the Palestinian quest for international recognition.
Germany is one of the most influential countries in Europe and one of Israel's most loyal allies.
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The Palestinians have been campaigning for UN membership for a state of Palestine in the West Bank, Gaza and east Jerusalem.
The Palestinians have won individual recognition of a state of Palestine from dozens of countries, but not from most of Western Europe. The status upgrades by Germany and other European countries do not necessarily mean they would vote for full UN membership.
Commenting on Germany's decision, Israeli Foreign Ministry spokesman Yigal Palmor said "the Palestinians will certainly interpret this as an encouragement to proceed with their rejection of direct talks, and that is a pity."
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