The fate of the Israeli Prime Minister Ehud Olmert hung in the balance today as his defence minister called on him to resign over corruption allegations or face the collapse of his coalition government.

A day after an American businessman told an Israeli court how he handed Mr Olmert envelopes stuffed with thousands of dollars in cash, Ehud Barak held a news conference to lay out the position of his Labour party, the junior partner in Mr Olmert’s coalition.

Mr Barak stopped short of action that would immediately bring down the government, but warned that he would use his influence to topple the administration if Mr Olmert does not go voluntarily.

“I don’t think the prime minister can at the same time lead the Government and handle his own affairs," said Mr Barak.

“Therefore, out of a sense of what is good for the country and in accordance with the proper norms, I think the Prime Minister must disconnect himself from the daily running of the government.

“He can do this in any of the ways open to him - suspension, vacation, or resignation, or declaring himself incapacitated. We will not be the ones to determine this.”

Mr Barak put the onus on Mr Olmert’s Kadima party to seek a new leader to replace the Prime Minister, and promised to continue to co-operate with a new leader.

“If Kadima does not act and a government is not formed during this current session of parliament that is to our liking, we will act towards setting an agreed and early date for elections,” he warned however.

A parliamentary election is not due until 2010, but a defection by Labour would almost certainly force an early ballot. Polls indicate that the right-wing opposition Likud led by Benjamin Netanyahu could be the strongest party after any snap election.

Mr Netanyahu is deeply sceptical of the present peace processes with the Palestinians and with Syria.

There was no immediate comment from Mr Olmert.

If the 62-year-old Prime Minister stepped aside temporarily while prosecutors pursued the corruption case against him, it would almost certainly be Tzipi Livni, his Foreign Minister and his deputy in Kadima and the cabinet, who would take over, for an interim period of 100 days. The pair do not get on well.

Morris Talansky, a US businessman, gave evidence yesterday that he gave Mr Olmert $150,000 in cash, stuffed into envelopes, over a 15-year period before he became Israel’s leader. The money included personal loans that were never repaid.

The image painted in court of a politician with a penchant for expensive cigars, pens and watches, first class air flights and luxury hotels, and for cash over cheques offered by the American-Jewish fundraiser, has caused enormous damage to Mr Olmert's already weak personal credibility. His popularity ratings have been in single figures, and even members of his own party want him to quit.

Mr Olmert has acknowledged receiving money from the New York-based businessman but said the funds were legal election campaign contributions. His defence lawyers will not have a chance to cross-examine Mr Talansky until July.

He has denied wrongdoing, and has said he will resign if he is indicted.

Tal Silberstein, one of Mr Olmert's adviser, told Israeli Army Radio before Mr Barak’s news conference that the prime minister had no intention of stepping aside now.

Mr Barak, prime minister from 1999 to 2001, had threatened to end his political partnership with Mr Olmert after the costly 2006 Lebanon war, but despite a criticial report on the conduct of the war Mr Barak did not follow through on his threat, saying that he would wait for a better time to call for Mr Olmert to go.