Israeli President Moshe Katsav will begin talks with the heads of parties on Sunday, in order to form a new coalition government.
Acting Prime Minister Ehud Olmert's centrist Kadima party won 28 seats in yesterday's general election, well short of a majority in the 120-member Knesset.
The Palestinian President, Mahmoud Abbas, said the results would not make any difference unless Mr Olmert changes his policy of retaining parts of the West Bank.
He was speaking after Mr Olmert declared victory, although Kadima won fewer seats than it had hoped.
Kadima will now try to form a coalition and pursue its pledge of establishing permanent borders, either with or without the agreement of the Palestinians.
The right-wing Likud party, which ruled Israel until three months ago, suffered a slump in support emerging with just 11 seats.
Speaking last night after exit polls showed his party would win, Mr Olmert told Mr Abbas that his country is ready to make compromises in the search for peace in the Middle East.
The Minister for Foreign Affairs, Dermot Ahern, said a crucial moment in the Middle East peace process had been reached.
Mr Ahern said it was important that any new government that emerges would remain firmly committed to negotiating a lasting and peaceful settlement of the Israeli-Palestinian conflict.
With 99% of the votes counted, the result (with projected seats) was: Kadima 21.8% (28 seats); Labour 15.1% (20); Shas (13); Yisrael Beiteinu (12); Likud 8.9% (11); NU/NRP (9); Pensioners (7); United Torah (6); Meretz (4); Others (10).
The total voter turnout was 63.2%, by far the lowest percentage in Israel's history. The previous low was notched in 2003, when 68% of eligible voters cast their ballots.
