The two neighbours have been involved in a decades-long conflict over the disputed territory.
In a joint statement released on Thursday night, the two countries said they saw a "historical chance" for "long-awaited peace".
Both countries said they hoped to sign a peace treaty by the end of the year.
EU Council president Charles Michel welcomed the move, calling it a "major breakthrough in Armenia-Azerbaijan relations".
The countries say they will work towards signing a full peace treaty based on mutual respect for each others' territorial integrity.
Baku is releasing 32 Armenian military servicemen and Yerevan is releasing two military servicemen, as a "gesture of goodwill".
Other moves include Armenia's support of Azerbaijan's bid to host the COP29 climate summit by withdrawing its own candidacy. Azerbaijan has agreed to support Armenia's candidacy of a regional group associated with the climate talks.
The two countries also called on the international community to support their efforts.
The agreement was reached during talks between the office of Armenia's Prime Minister Nikol Pashinyan and the administration of the President of Azerbaijan Ilham Aliyev.
Aliyev and Pashinyan have met on several occasions for normalisation talks mediated by the EU, the US and Russia.
Talks had stalled in recent months after Azerbaijan refused to participate in talks in the US and Spain, claiming bias on the part of Western countries. The two countries resumed talks again at the end of October in in Iran.
The Caucasus neighbours have been locked in a decades-long conflict over the Nagorno-Karabakh region, which surrendered to Azerbaijan after an offensive in September.
The offensive led to over 100,000 ethnic Armenians fleeing the area.
The territory is recognised internationally as part of Azerbaijan but large areas of it had been controlled by ethnic Armenians for three decades.
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