Sharon, who was once Israel's top hawk, will forge an alliance with Shimon Peres, the country's leading dove and the architect of the Oslo peace accords with the Palestinians, reports CBS News Correspondent Robert Berger.
The move came a day after Sharon easily won approval from his Likud Party to begin negotiations to bring its traditional rival into the government.
The Likud vote gave Sharon an important political victory as he pushes forward with his plan to withdraw from the Gaza Strip and four small West Bank settlements in mid-2005. A government with Labor, along with upcoming Palestinian presidential elections, also could help restart long-stalled peace talks between Israel and the Palestinians.
In other developments:
Labor leader Peres said Sharon called him early Friday to invite his party into coalition negotiations. Peres praised the Likud's decision to pursue unity talks and said his party would meet Saturday night to authorize him to open talks.
"I hope we should be able to move ahead in the direction of peace," he said. "It's not simple. It's not easy, but it is promising and the right step."
"Certainly we want to be part of a government that will choose the road of disengagement," said Labor parliament member Colette Avital.
A senior government official said Sharon also invited two religious parties to open coalition talks. The official, speaking on condition of anonymity, said negotiations with all parties would begin early next week, with the goal of quickly reaching a new coalition arrangement.
Hard-line opposition to the Gaza withdrawal plan and a falling out with the secular-rights Shinui Party, a key coalition partner, have left Sharon with a tattered minority in the 120-member parliament. With Labor's support, Sharon will regain a majority that appears poised to be able to carry out the withdrawal.
Much of the opposition to the withdrawal has come from within the Likud, which made Thursday's vote so critical for Sharon. Last May, the Likud rank and file overwhelmingly voted against the withdrawal plan in a party referendum. Sharon ignored the vote and pressed ahead.
Despite continued misgivings over the Gaza plan, the party's Central Committee voted 62 percent to 38 percent Thursday in favor of talking to Labor, preferring that alliance to the alternative of heading to early elections.
For decades, Sharon was the leading proponent of building settlements in the West Bank and Gaza, and his Likud hotly opposed conceding any land to the Palestinians. Over the past year, however, Sharon changed his policy.
Sharon says the Gaza settlements, with 8,200 Jews living among more than a million Palestinians, are untenable and must be removed.
He also believes the withdrawal will give Israel a better chance to retain its main settlement blocs in the West Bank, and says his plan will head off international peace efforts unfavorable to Israel.
Labor's inclusion in the government would come at a critical time. Parliament must still approve parts of the plan in the coming months for the pullout to begin on schedule next July.
The recent death of Arafat has also helped revitalize peace prospects. Sharon has said he is ready to coordinate the pullout — and perhaps resume full peace negotiations — with the new Palestinian leadership. Sharon refused to negotiate with Arafat, accusing him of backing violence.
Palestinian Cabinet Minister Saeb Erekat called the Likud vote an "internal Israeli matter" but said he hoped the new Israeli government will "go in the direction of reviving the peace process by holding meaningful negotiations with us."
Israel has given tacit support to Abbas, but does not want to openly embrace him in the run-up to the election.
Palestinian Planning Minister Ghassan Khatib cautiously welcomed the new Israeli proposal for northern Gaza, but said further withdrawals from Palestinian areas would be needed to reach a permanent peace deal.