The leader of Israel's ultra-orthodox Shas Party has resigned from his seat in the Knesset to allow it to negotiate a coalition with the victorious Labour Party.

Labour indicated that it would not be able to work with Shas while Aryeh Deri was its head, following his recent conviction on charges of corruption.

Meanwhile, hardliner Ariel Sharon has temporarily taken over the leadership of the Likud Party following Binjamin Netanyahu's resignation yesterday.

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Mr Deri, whose party is the third biggest in the Knesset, has resigned his seat to allow Shas to join a coalition if Prime Minister Elect Ehud Barak asks them.

Shas performed surpringly well in the elections, increasing its seats from 10 to 17 - just two fewer than the second largest party, Likud.

Mr Deri's four year sentence for corruption, bribery and fraud has been deferred, awaiting a Supreme Court appeal.

Following Binjamin Netanyahu's resignation from the leadership of the Likud Party on Monday, his foreign minister, Ariel Sharon, takes over in a temporary capacity.

This means that Likud - another possible coalition partner - is led by a right-wing hardliner.

Mr Barak is currently faced with the decision of what kind of government to form. He may have to work together with one of the religious parties.

Shas, because of its size, is one obvious choice. Shas is right-wing and orthodox, but has a middle of the road view on the peace process.

Ehud Barak: May leave Shas out of coalition

But the prime minister elect could also decide to leave Shas out of a coalition and ask Likud to join a government of national unity.

Likud could insist on agreeing policy guidelines before it joins such a government, and a united policy might be difficult to agree.

Mr Barak has set himself a difficult road by promising to kick-start the peace process, withdraw troops from Lebanon and take measures to reunite a fractured society.

He needs to avoid the dilemma of his predecessor, Binyamin Netanyahu, who was crippled by his fragile and diverse coalition.