Binyamin Netanyahu’s appointment as Prime Minister-designate this morning will be a bitter-sweet victory for the right-wing Israeli leader.

While clinching the nomination from President Shimon Peres, the smooth-talking, US-educated former commando — Bibi, as he is known in Israel — may find himself at the head of a narrow, far-right coalition that is at war with itself and at loggerheads with the new US Administration.

Headed by Mr Netanyahu’s Likud – which has lurched to the right since its former leader Ariel Sharon left to form the centrist Kadima party three years ago – and with its mainstay in the far-right Yisrael Beitenu party of Avigdor Lieberman, the new coalition will be able to count on 65 MPs in the 120-seat Knesset.

Bolstered by ultra-Orthodox and settler parties, Mr Netanyahu’s government will enshrine the neo-conservative, hawkish values of the Bush Administration, just at a moment when American has suddenly swung back to its more liberal values under Barack Obama.

George Mitchell, the peace envoy Mr Obama appointed almost as soon as he took office, has already fired a warning shot across Mr Netanyahu’s bows, saying yesterday that Israel needed to pursue a political track with the Palestinians, not just an economic one – which is what Mr Netahyahu has proposed.

Mr Netanyahu’s planned “economic peace” means effectively that Israeli forces would keep security control of the West Bank, including its borders and air space, while allowing Palestinians to police their own cities but with raids by Israel forces against militants deemed to pose a threat.

In return Israel would build industrial parks and attempt to boost the Palestinian economy, although it is unlikely that any Palestinian leadership could accept such terms and retain any credibility, especially with support for the militant Hamas on the rise.

Many on the Israeli Right fear that creating a Palestinian state would allow Hamas to take over the West Bank as it did Gaza, and put all of Israel’s central cities within its rocket range.

Mr Netanyahu has frequently accused Hamas of being Iranian proxies, intent on squeezing the Jewish state between Tehran-controlled enclaves.

"Iran is developing nuclear weapons and poses the greatest threat to our existence since the war of independence. Iran's terror wings surround us from the north and south," he reiterated today after accepting the president’s nomination to form a government.

Mr Lieberman has also spoken of the need to prevent Iran from going nuclear. Many fear that his bullish approach will set Israel on course for an imminent attack on Iran – especially since he has reportedly asked for a senior Cabinet position, such as foreign or defence minister, in return for backing Mr Netahyahu, who failed to win a majority of seats in last week’s elections.

Mr Netanyahu will be wary of giving too much away to Mr Lieberman, denounced by critics as a racist who has angered Israel’s large Arab minority with his rhetoric. Mr Lieberman has suggested giving away Arab areas of Israel in return for Jewish settlement blocks in the West Bank.

Mr Netanyahu is also loath to rely on a narrow, hard-right majority, which he did when first elected as Israel’s youngest prime minister in 1996. When he bowed to US pressure to implement Israel’s obligations under the Oslo accords, his government simply collapsed.

His current line-up will be fraught with tensions between the secular Yisrael Beitenu, which wants more civil institutions, and ultra-Orthodox parties who believe religious values should be reinforced.

For that reason, in the 42 days he has to form a government, Mr Netanyhu will be wooing Tzipi Livni, the head of the centre-right Kadima party who actually won more seats than Likud but could not form a stable parliamentary alliance. He also asked the Labour Party, still smarting from its worst election defeat, to join him in a national unity government.

Ms Livni was coy about joining such a hard-right formation. "A broad coalition has no value if it does not lead the way," she said after a separate meeting with Mr Peres. "There is a coalition here based on a lack of political vision, a coalition that will not allow me to exercise the way of Kadima."

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