The surprise announcement, made in an televised address to the nation on Wednesday evening from his residence in Jerusalem, is likely to ratchet up the calls for early elections – and throw peace talks with the Palestinians and the Syrians off kilter for at least the next two months.
"The moment has arrived for me to make a decision," Mr. Olmert said. "The smear campaign being waged against me these days has raised a question that I cannot and will not avoid. What is more important: my private justice or the public good?"
After about 2-1/2 years in office, the announcement shifts attention to Foreign Minister Tzippi Livni and Transportation Minister Shaul Mofaz, the two leading candidates in the Kadima Party leadership battle. Analysts say it's not clear that they'll be able hold together the ruling coalition.
The decision is in the hands of about 70,000 registered members of the centrist party, set up in 2005 by former Prime Minister Ariel Sharon. Polls which once favored Ms. Livni seem to be shifting toward Mr. Mofaz, a former army chief of staff, who some analysts say is backed by Olmert.
"It's very difficult to say. It's not clear what's going on in Kadima," says Gabriel Sheffer, a Hebrew University political science professor. "Some people say Mofaz has the advantage, and some people say it's Livni."
While Livni is considered more dovish, Mofaz is known as a security hawk.
Whoever wins will have a grace period of about a month to shore up commitments from new coalition partners. If they fail, Israeli law requires elections within 45 days. Such a scenario would favor the center-right Likud Party leader Benjamin Netanyahu, who currently enjoys a wide advantage over Livni, Mofaz, or Defense Minister Ehud Barak, the leader of the center-left Labor Party, according to a public opinion poll conduced by Israel's Channel 10 News.
Despite the resignation, Olmert has demonstrated remarkable political survival skills. And although he weathered successive waves of public outrage over his handling of the 2006 Lebanon War, he emerged considerably weakened.
In recent weeks, Olmert became the focus of a graft and bribery investigation, prompting a growing number of political allies to call for his resignation. The corruption inquiries exposed the Israeli prime minister to accusations that his positions in peace negotiations were calculated to deflect criticism from the criminal accusations – making it increasingly difficult to function.
"The Israelis will work out their own politics," spokesman Sean McCormack told the Associated Press. "We are going to look forward to working with all responsible Israeli leaders in the government, whether it is this government or some future government. I'm just not going to comment on their politics."
Even Arab negotiators in Syria and the Palestinian territories had remarked that Olmert's political capital had sunk so low that he was no longer a suitable partner for negotiations.
"Every day the burden of finishing work is enormous," says Gideon Doron, a Tel Aviv University political science professor. "It doesn't matter if the accusations are unfounded, he has had to fight more and more and more. It was like a tsunami. He lost his base of legitimacy."