Under the coalition deal with Ehud Barak, an administration led by Mr Netanyahu's right-wing Likud would respect all of Israel's international agreements, a formula that includes accords envisaging Palestinian statehood.
Mr Barak, an architect of Israel's recent Gaza offensive, is to retain his post as defence minister.
Labour's Central Committee voted its approval of the coalition deal after a stormy debate, when about 57% of nearly 1,200 delegates backed their leader's call to join the government.
'I am not afraid of Bibi Netanyahu,' Mr Barak told the assembly in a shaky emotion-filled voice during the earlier debate.
'I will not be anyone's fig leaf,' he said, dismissing talk that Labour would have little say on policy. 'We will be a counterweight that will ensure we do not have a narrow right-wing government.'
The Labour-Likud pact appeared to suggest a shift in focus in Israel's approach to peacemaking.
It made no specific mention of talks with the Palestinians, saying only a Netanyahu-led government would pursue 'a regional agreement for peace and cooperation in the Middle East'.
Mr Netanyahu has said his government would negotiate with the Palestinians but wanted the currently stalled talks to focus on shoring up their economy rather than on territorial issues that have stymied past discussions, an approach Palestinians reject.
With centre-left Labour in his corner, Mr Netanyahu would have a ruling majority of 66 seats in the 120-member parliament.
