Israel was facing a leadership crisis yesterday after the powerful Defence Minister demanded that Ehud Olmert, the scandal-hit Prime Minister, should step aside from office to concentrate on clearing his name.

Ehud Barak threatened to lead his Labour Party out of the government coalition and trigger snap elections if Mr Olmert, trapped in a quagmire of sleaze charges, did not adhere to his demands.

“I don’t think the Prime Minister can at the same time lead the Government and handle his own affairs. Therefore, acting out of concern for the good of the country, and for fitting norms, I believe the Prime Minister must detach himself from the day-to-day running of the Government,” said Mr Barak, a former prime minister.

He cited the security threats from Hamas in Gaza, Hezbollah in Lebanon and the threat of a nuclear Iran backing both as too serious to be relegated to second place by a prime minister fighting for his political life.

“He can do so in a variety of ways: suspension, vacation, resignation or leave of absence. This will not be determined by us,” added Mr Barak in an act of high-stakes brinkmanship.

While Mr Olmert has been facing calls from his own Kadima party and Labour to step down — at least temporarily — no one in either party wants to see the coalition collapse, which would be a direct consequence of a Labour walkout.

Polls consistently show that the right-wing Likud party, which has strongly criticised the current peace talks with the Palestinian leadership, would win early elections.

Mr Olmert’s position was looking increasingly untenable after courtroom testimony this week by an American businessman who said that he had given Mr Olmert at least $150,000 (£75,000) in cash, much of it in loose bundles in envelopes, over more than a dozen years before he became Prime Minister. The Attorney-General is considering whether he can charge Mr Olmert with bribery or illegal campaign financing.

Mr Olmert — who claims to be moving closer to a peace deal with the Palestinians and Syria — remains defiant. “I am going to continue to exercise my functions,” he said last night.

"Some people think that each time an investigation is launched, it has to lead to a resignation. But I don’t share that opinion — and I am not going to give up.”

Mr Olmert survived a similar leadership challenge last year from his own Kadima Foreign Minister, Tzipi Livni, who called for his resignation over his poor handling of the 2006 Lebanon war. He refused to quit, leaving Ms Livni politically weakened.

Mr Barak’s challenge appeared to be a far more serious act of defiance. “If Kadima doesn’t act and this parliament doesn’t see another government that is to our liking, we will act to set an agreed-upon date for early elections,” he said in a brief statement to the media. It will be difficult for Mr Barak, a shrewd political operator and the country’s most decorated soldier, to back down without a loss of face.

Mr Barak gave his Prime Minister no strict deadline, but said that he would not wait long for an answer. “The Labour Party is not going to stand in front of Kadima with a stopwatch, but things have to happen soon,” he said.

If Mr Olmert yields to the mounting pressure, Ms Livni would be appointed automatically as caretaker prime minister and could legally lead the Government for up to 100 days. She has been closely involved in talks with the Palestinian administration of President Mahmoud Abbas, whose spokesman voiced fears yesterday that the leadership crisis could hurt the fragile negotiations.

Opinion surveys in Israel showed an erosion of trust in the Prime Minister, who had already been investigated for corruption before the latest allegations that he granted political favours to Morris Talansky, the JewishAmerican businessman who said he paid for Mr Olmert’s family holidays abroad and bailed him out of hotel bills when his credit card was overextended.

A poll showed that 70 per cent of Israelis did not believe his defence that the money he received was used solely for election campaigns. Among his own party, that figure was 51 per cent. It remains to be seen whether the prosecutor’s office will be able to assemble a case for charging the Prime Minister. Mr Olmert’s aides said that paying a politician’s hotel bills was not illegal.

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