Mr Peters will be deputy to Prime Minister Jim Bolger, who threw him out of his cabinet five years ago, precipitating his expulsion from the National Party. He will also hold the new cabinet portfolio of Treasurer, giving him immense economic power, including the right to write budgets.
The decision marked an about-face by Mr Peters, who bitterly attacked Mr Bolger - Prime Minister for the last six years - during the recent election campaign, saying he was not fit to govern. The 50-year-old Maori courted controversy by criticising immigrants who he claimed had no commitment to New Zealand. He denied that he was racist.
NZ First's 17 MPs, who hold the balance of power following the inconclusive election, took nine hours yesterday to decide to join the 44 National MPs in the centre-right government rather than form a centre-left administration with the main opposition Labour Party.
Mr Peters and senior advisers had spent almost eight weeks negotiating detailed coalition agreements with the Nationals and Labour before putting them before his MPs. The length of yesterday's meeting indicated a vigorous debate, though Mr Peters said the final decision was by consensus. He said the decision was made in the interest of "the welfare and well-being of all New Zealanders".
The coalition will have an overall majority of only one in the 12-seat House of Representatives, but are likely to be supported on most issues by eight MPs of the right-wing ACT NZ party and the single United NZ member.
The National Party has made big concessions on economic policy, including deferring NZ$1.1bn (pounds 400,000) tax cuts scheduled for next July. The cuts were a major plank of National's campaign policy, but NZ First wanted them delayed to fund increased spending on social policies.