Mr Sharif has staked his name on restoring the judges to their jobs
One of the main parties in Pakistan has announced it is pulling out of the government, just three months after landmark general elections.
Ex-PM Nawaz Sharif says his PML-N is quitting because of differences over the reinstatement of judges sacked by President Pervez Musharraf.
Mr Sharif wants the judges, who became a focus of opposition to Mr Musharraf, to get all their old powers back.
But the biggest party, the PPP, wants limitations on their powers.
Both sides were eager to avoid the appearance of a major rift, but analysts called the pull-out a huge set-back that could lead to growing instability.
The BBC's Barbara Plett in Islamabad says further cracks in the alliance may give a lease of life to pro-Musharraf parties which were defeated in recent elections.
"Our ministers will meet the prime minister tomorrow and will submit their resignations," Mr Sharif told journalists in Islamabad after meeting party colleagues.
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The judges' issue should be put on back burner and other issues like state of economy and energy crisis should be addressed.
However, he indicated that he would support the Pakistan People's Party-led government from the backbenches on an issue-by-issue basis. "We will not become part of any conspiracy to destabilise the democratic process," he said.
Mr Sharif also announced that he would run in a by-election next month in the city of Rawalpindi.
He said that the coalition had twice failed to meet deadlines to restore the judges sacked by President Musharraf.
Reinstating the judges was one of Mr Sharif's key election promises and his condition for joining the coalition.
A statement from the PPP called the PML-N move "a pause in the process and not a break in the purpose of restoration of judges".
It said ministries vacated by the PML-N would not be filled and hoped the issue could be resolved "amicably and in a spirit of accommodation and mutual trust".
The party also said it had no plans to field a candidate against Mr Sharif in the Rawalpindi by-election.
The alliance had set Monday as the latest deadline to reinstate the judges, but Mr Sharif and the Pakistan People's Party leader, Asif Zardari, wrapped up talks in London without reaching a deal.
March 2007: President Musharraf suspends Supreme Court chief justice, triggering protests
6 Oct 2007: President Musharraf wins election
3 Nov 2007: President declares state of emergency and sacks around 60 judges
22 Nov 2007: New Supreme Court upholds Musharraf election win
18 Feb 2008: New coalition government of PPP and PML-N emerge victorious in parliamentary polls
30 April 2008: Deadline set by two parties to reinstate sacked judges
12 May 2008: Second deadline to restore judges
The new government had initially promised to restore the senior judges by the end of April.
Ten days ago, following earlier talks, Mr Sharif announced that all the senior judges sacked by President Musharraf last year would be reinstated on 12 May.
Mr Sharif's party has campaigned for the unconditional reinstatement of the judges.
Mr Zardari wants the reinstatement of the judges to be part of a larger package of constitutional amendments which would include reducing their powers.
President Musharraf sacked about 60 judges - some sitting in the Supreme Court - in November 2007, after declaring a state of emergency.
The Supreme Court had been due to rule on whether his re-election was legal.
They had also been due to rule on a controversial amnesty covering Mr Zardari and his wife Benazir Bhutto, who was later assassinated.
Monday's news came as the Commonwealth decided to re-admit Pakistan as a member.
Pakistan was suspended in November after President Musharraf refused to meet a deadline to lift the state of emergency and resign as army chief.