An Israeli right-wing party has pulled out of the coalition government in protest at the starting of peace talks on core issues with the Palestinians.
Mr Lieberman is one of the most outspoken right-wingers in Israel
Yisrael Beitenu leader Avigdor Lieberman said the land-for-peace talks would lead to Israel's destruction.
Israeli Arab politicians condemn the party as racist for advocating the expulsion of Arab citizens from Israel to a future Palestinian state.
Despite its departure, the coalition still retains a parliamentary majority.
However, it is only by seven seats, meaning Ehud Olmert's government is now vulnerable to any similar withdrawal by the religious party Shas.
Shas has 12 seats and has also threatened to leave the coalition over the issue of peace talks.
"A few minutes ago, I spoke to the prime minister and I also gave him a written announcement of our departure from the coalition and my resignation from the government," Mr Lieberman said.
"Negotiations on the basis of land for peace are a critical mistake... and will destroy us," the outgoing strategic affairs minister and deputy prime minister told a news conference.
"It is clear to everyone that these talks will lead to nothing."
Correspondents have often highlighted the contradictions of Mr Lieberman's participation in a coalition pledging to make peace with the Palestinians.
He is one of Israel's most outspoken hardliners, who has in the past suggested bombing Egypt's Aswan Dam and executing Israeli Arab MPs, as well as reportedly calling for Palestinian prisoners to be drowned.
Israeli police remove a settler from an outpost near Nablus
Mr Olmert's political vulnerability could increase later this month, with the publication of an inquiry into the 2006 Lebanon war, which is expected to criticise his government.
But a statement by Mr Olmert's office said final status talks - on Jerusalem, borders, Jewish settlements and Palestinian refugees - were "the only real chance of ensuring the peace and security of Israeli citizens".
The departure of Yisrael Beitenu, which appeals to Israel's large immigrant community from the former Soviet Union, leaves the coalition led by Mr Olmert's Kadima party with 67 seats in the 120-seat chamber.
Israeli forces evacuated two small settlement outposts in the West Bank, in line with commitments it has made in the faltering US-sponsored peace process.
At one outpost, near the Palestinian town of Nablus, the five settlers living there fled when the soldiers arrived and no arrests were made.
At a second outpost nearby, Shvut Ami, bulldozers demolished one of two partly built houses.
A small protest was held by about 20 teenagers who were eventually removed by the security forces.
Israeli campaign group Peace Now estimates that about 3,000 Jewish settlers live in outposts - embryonic settlements not authorised by the Israeli government.
About 430,000 settlers live in the West Bank, including East Jerusalem, on settlements authorised by the Israeli government.
All settlements are considered illegal under international law, though Israel disputes this.