* Exit polls give Livni slender lead over Netanyahu * Final result too close to call, both say they should be PM * Third-placed rightist keeps coalition options open * Neither outcome likely to favour progress on peace deal By Ari Rabinovitch and Allyn Fisher-Ilan TEL AVIV, Feb 10 (Reuters) - Israeli Foreign Minister Tzipi Livni claimed victory in Tuesday's election but her right-wing challenger Benjamin Netanyahu said he should be prime minister after a cliffhanger vote that was too close to call. Exit polls gave Livni's centrist Kadima party a two-seat lead over former premier Netanyahu's Likud. But neither won more than a quarter of parliament's seats and the early counting showed the right narrowing the gap to just a single seat. An overall rightward shift in the Knesset will, in any case, dent hopes in U.S. President Barack Obama's administration for an Israeli coalition that can drive forward in making peace with the Palestinians and other Arab neighbours after last month's war in the Gaza Strip. "The Israeli public can smile again when we form the government," Livni told cheering supporters, urging her main rival to join a national unity coalition under her leadership. But Netanyahu said polls showed there would be a right-wing majority in Israel's highly fragmented parliamentary system and that his Likud party would be able to head a new coalition. "With God's help I will lead the next government," he said. A tight finish once tallies are complete on Wednesday will hand a key role to President Shimon Peres, who in theory can nominate any legislator to try to form a government. In practice, there is no precedent for not nominating the leader of the biggest party immediately after an election. It is likely to be weeks before a new cabinet can be formed. Potential kingmaker Avigdor Lieberman kept his options open after his far-right party dominated by fellow Russian-speaking immigrants surged into third on a wave of anti-Arab rhetoric. Palestinians said they had little expectation of progress on their demands, whether Livni or Netanyahu became premier. Just getting so far was an achievement for the 50-year-old former Mossad agent and corporate lawyer who wants to become Israel's first woman leader since Golda Meir in the 1970s. Former premier Netanyahu was cruising to victory until Livni and the centre-left coalition under outgoing prime minister Ehud Olmert launched a three-week offensive in Gaza. It won massive popular support in Israel despite an international outcry over the 1,300 Palestinians killed in the Hamas-ruled enclave. POLL STANDINGS Exit polls on three Israeli television channels showed Kadima retaining around its present 29 seats in the 120-seat, single-chamber Knesset, with Likud two seats behind. With votes from half the 9,263 polling stations counted, Kadima's lead was just 29 seats to 28. Soldiers, whose votes could account for a couple of seats, were excluded from exit polls and that could favour Netanyahu as tallying continues. "By morning we will be ahead. When the soldiers' votes come in, we will be way ahead," Likud lawmaker Yuval Steinitz said. One television station put the right-left split at 64 seats for the right to 56 for the left, which could persuade Peres to break with tradition and nominate Netanyahu as premier. Kadima cabinet minister Yaacov Edri conceded Livni could struggle to build a coalition. But he added: "It won't be easy, but the Israeli public has had its say, and it's Tzipi." Yisrael Beiteinu (Our Home is Israel), a far-right party led by former Netanyahu aide Lieberman, was forecast to win about 15 seats, up from its current 11. That disappointed many supporters, after poll scores last week as high as 19. But the party's performance still appeared to have dented Likud. Mark Heller of Tel Aviv University said: "Netanyahu felt the right-wing parties nipping at his heels. He shifted his own focus to the right to head that off, and thereby lost some votes in the centre ... A lot of people were at the last minute frightened off by the idea of Netanyahu being prime minister." Lieberman said his "heart's desire" was a right-wing coalition -- but he added: "We're not ruling anyone out." The Labour Party of Defence Minister Ehud Barak, another former prime minister, trailed in fourth place with 13 seats, according to exit polls, down from 19 at present. The party of Israel's founders and the dominant force for its early decades, Labour has suffered from a rightward shift of the electorate. COALITION CALCULATIONS Whoever Peres nominates has six weeks to form a government. Livni's failure to cobble together a new coalition in November following Olmert's resignation in a corruption scandal triggered the election more than a year ahead of schedule. Livni led peace talks with the Palestinians on a two-state solution, which stalled last year but which U.S. President Barack Obama wants to resume. Netanyahu is cooler on ceding occupied territory to Palestinians and is more likely to resist U.S. demands to curb settlement expansion in the West Bank. During his three years in office to 1999, the U.S.-educated Netanyahu had strained relations with the last Democratic president, Bill Clinton, and Washington analysts believe a Livni administration would be favoured by the White House. However, her hands would still be tied by right-wing parties. Senior Palestinian negotiator Saeb Erekat said: "Regardless of the coalition formed ... the next Israeli government will be unable to deliver the requirements of peace ... This election did not focus on making peace with the Palestinians. "Israelis' eyes are turned towards war with Iran." Netanyahu has repeatedly said he would not sit by if Iran acquired nuclear weapons, something Israel believes it is trying to do, despite Tehran's denials. That leads some analysts to see a Netanyahu government as more likely than another to consider a military strike on Iran, even if its U.S. ally disagrees. Olmert will stay on as caretaker premier throughout the period when a new government is being formed. (Additional reporting by Adam Entous, Joseph Nasr, Ori Lewis, Alastair Macdonald, Jeffrey Heller, Dan Williams, Steven Scheer and Douglas Hamilton in Jerusalem, Wafa Amr in Ramallah and Tova Cohen in Tel Aviv, in Jerusalem, Writing by Alastair Macdonald, Editing by Jeffrey Heller and Michael Roddy) (douglas.hamilton@reuters.com; +972 2 632 2202; Reuters Messaging: douglas.hamilton.reuters.com@reuters.net)) (For blogs and links on Israeli politics and other Israeli and Palestinian news, go to http://blogs.reuters.com/axismundi)
Members of Neturei Karta, a fringe ultra-Orthodox movement within the anti-Zionist bloc, take part in a protest against Israel's parliamentary election in Jerusalem's Mea Shearim neighbourhood February 10, 2009. Israelis voted ...
