After the walkout, Prime Minister Ariel Sharon moved to create a narrower coalition of rightwing parties. Failure to do so would lead to early general elections.

Sharon's first move was to appoint hardline former chief-of-staff Shaul Mofaz as the new Defence Minister, replacing Ben-Eliezer. The most likely prospective Likud partner in a new government is the extreme rightwing National Union-Yisrael Beitenu alliance.

Both the main parties are expected to face leadership challenges before any new election. Former prime minister Benjamin Netanyahu is expected to confront Sharon in a Likud poll, while leftwingers Haim Ramon and Amran Mitzna will vie with Ben-Eliezer for the Labour leadership. In a general election, recent polls have forecast that Labour would lose ground to Likud and the far right.

Attempts by politicians to avert the crisis were doomed by the Sharon government's commitment to the extra funding for settlements. His budget proposed $145 million to support settlers, who in recent weeks have been increasingly militant, occupying hilltop outposts and preventing Palestinian farmers from harvesting olives. Despite Labour's opposition, the budget passed its first reading by 67 votes to 45.

'We have been quiet until now because we preferred unity,' said Ben-Eliezer as he tended his resignation to an angry Sharon. 'But now there is no choice but to take from the settlements.'

Palestinian cabinet minister Saeb Erekat warned that the Palestinians were likely to be the victims of a far-right coalition. 'If there is a new coalition between the Likud and the rightwing in Israel, it will be at the expense of the Palestinian people and against the peace process.'