Mr Sharon spoke after Labour - a member of Israel's governing coalition - asked its members of parliament to vote against the austerity budget due to be debated on Wednesday.

The responsibility for passing the budget lies with everyone, and anyone who does not demonstrate this responsibility... will not belong to the government

Ariel Sharon

The Labour leader and Israeli defence minister, Binyamin Ben-Eliezer, said his party would quit the government unless about $150m allocated to settlers in the West Bank and Gaza was diverted instead to social spending.

If no compromise is found and the coalition government collapses, fresh elections will have to be held in three months' time.

Meanwhile, there was continuing violence in the region over the weekend.

A Palestinian suicide bomber killed himself and three Israeli soldiers at the entrance to a Jewish settlement in the northern West Bank on Sunday. Sixteen others were injured.

Israeli forces shot dead two militants in Nablus, and another Palestinian in nearby Jenin.

'Essential for the economy'

Mr Sharon said the budget was "not easy" but neither was Israel's situation.

"It is a budget which is essential for stabilising the economy," he said.

"The responsibility for passing the budget lies with everyone, and anyone who does not demonstrate this responsibility, I say clearly, will not belong to the government," Mr Sharon said.

The Israeli leader has been forced to propose the spending cuts to offset the high defence costs needed to combat the Palestinian uprising - and also because of a steep fall in tax revenues due to a domestic recession.

Israel has to cut back in other areas to pay its military budget

Labour, however, says the Jewish settlers are not bearing their share of the cuts.

It wants 700 million shekels ($147 million) of the settlers' allocation to go to pensioners, one-parent families, students and poor towns.

Labour's Ephraim Sneh told army radio the settlers were a "privileged" group.

"They are the only ones not touched by the planned cuts in the budget, and we cannot accept this," he said.

Challenge set

BBC correspondent Jim Fish said that by coming out against the budget, the Labour Party leadership has thrown down the gauntlet to Ariel Sharon's Likud Party.

Mr Ben-Eliezer is being strongly challenged for the Labour party leadership and if the government proposals fall, it might just tip the contest in his favour.

Yasser Arafat is under international pressure to reform his government

Mr Sharon would then face a strong and possibly decisive challenge from former Likud Prime Minister Binyamin Netanyahu, our correspondent says.

Meanwhile, the Palestinian leader, Yasser Arafat, has postponed a meeting of his Legislative Council after Israel prevented 13 legislators from travelling to the West Bank city of Ramallah to attend it.

The meeting had been called to vote on Mr Arafat's proposed new cabinet.

The previous cabinet quit en masse in September, to avoid losing a confidence vote by lawmakers in the Palestinian parliament.

Mr Arafat is under international pressure to reform his Palestinian Authority and rein in militants as a prelude to resuming peace talks with Israel.