Israeli Foreign Minister Tzipi Livni arrives at the weekly cabinet meeting in Jerusalem, Israel. (Jim Hollander/Getty Images )
Representatives from the two parties, already partners in the outgoing government of Prime Minister Ehud Olmert of Kadima, initialled the draft accord, which still needs to be finalised and ratified by party institutions.
A political partnership with centre-left Labour would still leave Livni short of a workable parliamentary majority.
Kadima officials said she planned to continue efforts to persuade the Jewish ultra-Orthodox Shas party to join a coalition under her leadership.
"If we don't accomplish this task, there won't be a government," senior Kadima negotiator Tzachi Hanegbi, referring to a future deal with Shas, told Channel Two television after he initialled the agreement with Labour.
Israeli media reports said that under the accord with Labour, Barak would be appointed deputy prime minister while continuing to serve as defence chief.
Labour, the reports said, backed away from its demands that a new government raise from 1.7 percent to 2.5 percent the maximum annual increase in budgetary spending allowed by law.
Barak said last week Labour's calls for increased social spending had become less urgent as a result of what he termed the worldwide "financial tsunami".
Livni was elected by members of centrist Kadima last month to take over as party leader from Olmert, who resigned as prime minister in a corruption scandal. He remains in office in a caretaker capacity until a new government is formed.
Under a presidential mandate, Livni has until early November to present a new cabinet. Failure to do so would likely lead to an early parliamentary election.
Opinion polls indicate a national ballot now would be won by the right-wing opposition Likud party led by Benjamin Netanyahu.
Both Kadima and Labour have pledged to keep pursuing a peace deal with Palestinian President Mahmoud Abbas. U.S.-sponsored statehood negotiations that began last November have made little progress.
