The resignation of Israel's armed forces chief over failure to win last summer's Lebanon war dealt a fresh blow to Prime Minister Ehud Olmert, already weakened by political scandal.
Israeli media described Lieutenant-General Dan Halutz's decision to quit as an earthquake and speculated whether it might ultimately trigger a domino effect toppling Mr Olmert and Defence Minister Amir Peretz.
Israeli Prime Minister Ehud Olmert speaks with Chief of Staff General Dan Halutz at a military base near Tel Aviv last August
"He did not agree to my request that he reconsider. I very much regret the chief of staff's resignation," Mr Olmert said in a statement in which he called Gen Halutz one of Israel's "greatest warriors" but made no comment on his conduct of the Lebanon war.
The former fighter pilot's move was announced hours after Israel's state prosecutor ordered a criminal probe into Mr Olmert's role in the privatisation of Israel's second biggest bank in 2005, when he was finance minister.
Mr Olmert has denied any wrongdoing in the sale of Bank Leumi or in another case, now being considered by Israel's attorney-general, into the alleged appointment of cronies to a government-funded business authority.
His troubles could weigh heavily on Washington's new push to revive Israeli-Palestinian peacemaking, efforts that it hopes can bolster Palestinian President Mahmoud Abbas in his power struggle with the governing Islamist group Hamas.
That push took a new twist today when it emerged that Israel plans to release nearly $100 million in withheld Palestinian tax revenues to Mr Abbas by Friday.
Mr Abbas could use the money to help make long-overdue salary payments to Palestinian public sector workers, hard hit by a Western and an Israeli embargo of the Hamas-led government.
During his first formal meeting with Mr Abbas on December 23rd, the Israeli prime minister promised to hand over the $100 million and to remove roadblocks in the occupied West Bank.
Since that meeting, Mr Abbas's allies complained that Israel has been undercutting him by taking its time to deliver on its promises.
Mr Abbas, who met US Secretary of State Condoleezza Rice in the West Bank city of Ramallah on Sunday, asked Washington to intervene. Ms Rice held talks with Mr Olmert on Monday in Jerusalem.
"We hope to transfer the full amount by Friday," a senior Israeli government official said today. Palestinian officials who have been negotiating the transfer had no immediate comment.
The return of the money could damage Mr Olmert further however, with some Palestinians already seeing his administration as weak and Israelis clearly already unhappy with their premier.
Mushir al-Masri, a senior Hamas legislator said in Gaza that investigations against Mr Olmert and Gen Halutz's resignation "prove the Zionist government is weak" and should spur Palestinians "to continue resistance and jihad".
An Israeli poll published last week indicated Mr Olmert's approval ratings had slipped to 14 per cent. The survey showed his centrist Kadima party would lose nearly two-thirds of its strength in an election.