The Labour party's 20 Knesset members could become more influential than expected under its leader, Amir Peretz, in a new coalition, after Mr Olmert's Kadima party secured just 28 seats, significantly fewer than predicted.
Mr Peretz's influence may in time be reflected in pressure on Mr Olmert to begin a negotiating process alongside his plans for withdrawal from settlements east of the 450-mile separation barrier, sections of which cut deep into the West Bank.
The probably unilateral withdrawal could affect a total of about 70,000 settlers.
Otiniel Scheller, a Kadima Knesset member said yesterday that Kadima would need at least a year to finalise a detailed plan to withdraw from parts of the West Bank. Mr Scheller, a settler who said he been drawing up the plan over the past few weeks said that, for the first year or so, the government would wait to see whether the new Hamas-led Palestinian government would recognise Israel, accept past agreements, and renounce violence. In the meantime, Mr Olmert would talk to Jewish settlers about alternative places to live, he said. The present barrier cuts into the West Bank to the east of the 1949-1967 "green line" between Israel and the Palestinian territories, leaving former Palestinian agricultural land as well as the biggest settlement blocks on the Israeli side of the barrier.
In the following two to three years, Israel would build alternative communities for the settlers, either in the big West Bank settlement blocs that Israel intends to retain between the pre-1967 border and the 450-mile separation barrier or in areas in Israel. Mr Scheller insisted the new borders would allow a contiguous Palestinian state, though in the absence of a peace deal the Army would remain in the evacuated areas. "The wisdom of the plan is that there is no precise timetable," he added.
As some of the 11 members in the depleted Likud party showed signs of turning on their leader, the former prime minister Benjamin Netanyahu, there was increasing speculation that Mr Olmert planned to form a coalition with Labour, one or both of the two ultra-orthodox parties, and the Pensioners' Party.
The success of the latter party, led by the former Mossad spymaster Rafi Etian - which in its first entry into the Israeli parliament secured seven seats for its single-issue programme - was the biggest surprise of the election.
Mr Netanyahu, who insisted on Tuesday he would carry on as leader, was confronting the implications of a double defeat for Likud's right-wing ideology.
The first defeat was that his consistent raising of the spectre of a newly-empowered Hamas failed to impress Israeli electors to vote for him as the leader of the one big party unambiguously opposed to unilateral withdrawals from occupied territory.
And the second was a fierce backlash against his neo-Thatcherite welfare-cutting polices. One senior government official said he judged Mr Peretz as one of the key victors of the election because of his success in mounting an assault on Mr Netanyahu's social policies. "This is the first election in which social and economic issues have been at the forefront along with the security issue," the official said.
That was reflected in the gains made not only by Labour but also by the Pensioners Party and the ultra-orthodox Shas, which took 11 seats. Labour reportedly contacted Shas and the Pensioners' Party last night in an attempt to form a "social bloc" for coalition negotiations that the senior Kadima Knesset member Haim Ramon said he expected to be completed soon after the Passover holiday in mid-April.
Mr Peretz has repeatedly made it clear that he wants to see negotiations with Mahmoud Abbas and that unilateral measures should only be taken as a last resort. Ismail Haniyeh, the new Hamas Palestinian Prime Minister said after his Cabinet was sworn in by Mr Abbas in Gaza yesterday that " whatever Mr Abbas presents to the people as a result of the negotiations serves our interests, then we will also redefine our position."
President George Bush congratulated Mr Olmert on his victory yesterday and invited him to the White House.
Mr Olmert indicated again he was ready for negotiations if Hamas reversed its refusal to recognise Israel. But he has made it clear he will seek to negotiate new borders annexing the largest settlement blocs with the US and with sectors of Israeli society, including the settlers if he cannot negotiate with the Palestinians.
Although the plan for settlement withdrawals will be warmly welcomed by the international "Quartet" of the US, EU, UN and Russia, the idea of unilaterally fixed borders may trigger international disquiet. Tony Blair yesterday welcomed Kadima's victory as one that "changes the shape of Israeli politics."
He added: "I look forward to meeting him soon to discuss his plans to take the peace process forward. I urge all parties to pursue a path of positive engagement as set out by the Quartet"
New players in the Knesset
KADIMA (28 seats)
Centrist party headed by acting Prime Minister Ehud Olmert, who calls for Israel to impose final borders in the absence of peace talks with the Palestinians.
LABOUR (20)
Headed by Amir Peretz. Supports West Bank withdrawal.Expected coalition partner with Kadima.
SHAS (13)
Ultra-Orthodox partyhas a middle-ground view on the conflict. A potential coalition partner.
YISRAEL BEITENU (12)
Ultranationalist party which has called for ceding villages to the Palestinians in exchange for Jewish settlement blocs.
LIKUD (11)
Suffered its worst election defeat in decades. Opposes unilateral withdrawals and said it would not seek to join a Kadima-led coalition.
NATIONAL RELIGIOUS PARTY/NATIONAL UNION (9)
A merger of Jewish settlers who opposed last year's Gaza Strip withdrawal. Unlikely to join a coalition.
ARAB PARTIES (10)
Left-wing parties that call for a withdrawal from occupied land.
OTHERS (17)
'The victory of the centrist sensibility marks the end of extravagant dreams'
Amira Hass WRITER & JOURNALIST, HAARETZ
"This election result is alarming. The parties that will make up this future coalition know how to lead us to what they call 'peace', but what is actually a situation keeping the Palestinians in an unviable state. Talk of withdrawal from Palestinian territory is nice in theory. But we are still talking about occupation. I am suspicious of this kind of 'progress'."
David Horovitz EDITOR-IN-CHIEF, JERUSALEM POST
"If the results of exit polls are reflected in final figures, then the elections are a vindication of Sharon - the stricken PM, the man who so conspicuously wasn't there for this campaign. Sharon, it appears, didn't merely break away from the Likud with Kadima. He broke the Likud. And the results are a stinging rejection of Netanyahu - the politician and the ideology."
Yossi Klein Halevi POLITICAL ANALYST AND WRITER
"The victory of the centrist sensibility marks the end of Israel's extravagant dreams. The collapse of utopian ideology is a sign of the country's maturation. The settlement movement ignored the moral corruption of occupation and the demographic threat to Israel's identity as a Jewish and democratic state posed by the forcible absorption of millions of Palestinians into Israeli society."
Pinchas Wallerstein LEADER OF PSAGOT SETTLEMENT
"Our public is worn out. It went through an expulsion and the Amona incidents. We have to self-examine ourselves. If someone thinks what happened in Amona was an isolated incident, he is hallucinating. There is no leftist majority here for a unilateral disengagement... a withdrawal of the kind that we saw in [Gaza's] Gush Katif, with hugs and kisses, will not repeat itself."
Yair Lapid SCRIPTWRITER, ACTOR AND COLUMNIST FOR YEDIOTH AHRONOTH
"The people do not want to continue to hold on to the [occupied] territories, it supports the next disengagement, and it isn't willing to see its grandfather starve to death."
Michael Dahan POLITICAL SCIENTIST
Both Netanyahu and Olmert referred to the election in terms of a referendum. I think the public also treated it as such. Those that voted seemed to consider their votes carefully, and voted strategically in order to strengthen Kadima's chances to withdraw from the territories. Olmert has quite a job."
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