Shimon Peres has been ousted as leader of Israel's Labour Party in a political upset which threatens to torpedo Ariel Sharon's shaky ruling coalition.

In a close-run leadership contest, Mr Peres, the 82-year-old statesman, was defeated by Amir Peretz, a fiery 53-year-old union secretary.

Mr Peretz promised the centre-left Labour Party membership that he would immediately withdraw from the coalition government that Mr Peres forged with Mr Sharon's Likud Party.

Such a move would bring forward elections due in November next year. Although Mr Sharon remains popular among the electorate, he is vulnerable within Likud, which is deeply divided over the Prime Minister's policies.

Mr Peres became Israel's Foreign Minister when he led Labour into a partnership with the right-of-centre Likud last year. The coalition enabled the controversial clearance of Israeli settlers from the West Bank and Gaza and allowed Mr Sharon to survive several subsequent no-confidence votes from the Right of his party.

Celebrating his victory, Mr Peretz said he would meet Mr Sharon on Sunday to take Labour out of its coalition with Likud.

"This can truly be Israel’s most important hour," said Mr Peretz. "We will notify the Prime Minister that we want to leave. We want to leave... certainly out of a desire to turn the Labour Party into an alternative that intends to take power in the next elections."

Mr Peretz, who is the head of Israel’s Histadrut trade union federation, but largely unknown on the international stage, won 42 per cent of the party membership vote to Mr Peres's 40 per cent after campaigning to return Labour to its roots as the party for Israel's working poor.

Born in Morocco, Mr Peretz is the former leader of Am Ehad, a socialist worker's party. He portrays himself as an earthy populist who is determined to reverse Mr Sharon's free-market reforms and spending cuts in favour of social justice for the less well-off.

His victory has been described as one of the greatest upheavals in Israeli politics since 1977, when Labour first lost power after 29 years of unchallenged rule.

Labour, the "Old Lady" of Israeli politics, has steadily lost seats in the Knesset (the Israeli parliament) since Ehud Barak, the party's last Prime Minister, fell from power in 2001.

Mr Peres was widely expected to be returned as the leader of the party, in which he has served as member of the Knesset since 1959. But political analysts in Israel had suggested that his popular support was waning.

Although he has twice served as the Prime Minister of Israel and is revered internationally for his role in the Oslo peace accords of 1993, Mr Peres has failed to win power in five elections as Labour leader.

He has bounced back from the political wilderness many times before, but confessed: "I expected a better evening."

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