JERUSALEM (Reuters) - Prime Minister Ariel Sharon has ousted hawkish rival Benjamin Netanyahu as foreign minister in a surprise move after forging a rightist coalition likely to harden Israel's line against a Palestinian uprising.

Silvan Shalom, a Sharon ally who has served until now as finance minister, agreed to take on the foreign ministry in the new government that the prime minister began forming after his right-wing Likud party's election victory in January.

In a move clearly engineered to undermine his longtime political rival, Sharon asked Netanyahu, a former premier, to become finance minister, a step down in the cabinet hierarchy.

Netanyahu, who was defeated by Sharon in a bitterly fought race for the Likud leadership last year, refused the offer, Sharon's office said.

But after Sharon aides asked him to reconsider, he presented conditions for accepting the job, including broader control over company privatisations and the status of acting prime minister when Sharon goes abroad, media reported. It was unclear how Sharon would respond.

Shalom, 44, has little foreign policy experience. He is seen as loyal to Sharon and his appointment is unlikely to bring big changes to Israel's foreign policy, foreign diplomats said.

"I don't think this will make much difference to foreign policy. Sharon will strengthen his grip on foreign policy with a weaker person as foreign minister," a European diplomat said.

If Netanyahu does not become finance minister, Sharon was expected to turn to former Jerusalem mayor Ehud Olmert to lead efforts to revive an economy battered by a global slowdown and nearly 2-1/2 years of Israeli-Palestinian violence.

Sharon said Defence Minister Shaul Mofaz would remain in his post in the new government.

Likud reached a coalition deal early on Wednesday with the centrist Shinui party, the ultranationalist National Union party and the National Religious Party (NRP), a champion of Jewish settlements on occupied land.

The coalition parties signed an agreement giving Sharon a government with 68 seats in the 120-seat parliament.

PRESSURE ON SHARON

The inclusion of the right-wing parties will increase pressure on Sharon to take an even tougher line against the Palestinians and could make it harder for international mediators to end the Israeli-Palestinian conflict.

Sharon, who turned 75 on Wednesday, is expected to present the coalition to parliament, the Knesset, on Thursday.

The Palestinians, seeking their own state, are wary of the new government because of the expected shift to the right.

"It is obvious from the nature of the agreements and the nature of the parties that the Israeli government will be a government of settlement activities, of more military escalations and incursions," Palestinian cabinet minister Saeb Erekat said.

"The only thing that will be absent is the peace process."

Sharon had tried to bring the centre-left Labour Party into the coalition to avoid being dependent on right-wing parties.

But Labour pulled out of negotiations on Sunday, saying it could not find a common basis with Sharon on dismantling some Jewish settlements and lifting the economy out of recession.

Labour's decision left Sharon lacking the more moderate partner he sought ahead of anticipated U.S. pressure for concessions to the Palestinians after any U.S.-led war on Iraq.

There was no immediate word of fresh violence in the West Bank or Gaza Strip. A rare snowstorm which kept Jerusalem under a blanket of snow for the second day also hit the West Bank.

At least 1,874 Palestinians and 706 Israelis have been killed since the uprising erupted in September 2000 after negotiations on a Palestinian state broke down.