This comes as Israeli aircraft fired two missiles into the compound of the Palestinian Authority headquarters in Gaza City, killing one person, in a sign of the ever worsening relations between the two sides, despite the Hamas-led Palestinian government saying it is ready to live 'side-by-side' with its neighbours.
Mr Katsav said that Mr Olmert, whose Kadima party gained the most seats in last week's general election, was the best placed to form the next government.
"The president has not yet taken an official decision but it is clear that Ehud Olmert is the best placed because he has the support of the majority of parties," said spokeswoman for the president, Hagit Cohen, speaking to AFP.
"The support he was given publicly by Amir Peretz has only strengthened that," said Ms Cohen, referring to the leader of the centre-left Labour party, which gained 20 parliamentary seats, second only to Kadima's 29.
Path ahead
After days of sniping, Mr Olmert and Mr Peretz announced they would work towards forming a coalition, which will still need the support of several other smaller parties.
"We are glad to announce that, after President Moshe Katsav appoints me to form a government, we will start coalition talks to create a government in which Labour will be a senior partner," said Mr Olmert, who will have to cobble together a broad coalition that is willing to pull Israelis out of the West Bank.
The Pensioners party, surprise winners of seven seats, has already given him the nod, and the ultra-Orthodox Shas party is also expected to come on board in return for control of the interior ministry.
Mr Peretz, despite earlier who had earlier touted the possibility of forming a Labour-led government, said there is a "new basis for cooperation between Labour and Kadima".
"A government led by Kadima and its chairman Ehud Olmert will be stable and able to hold the full-year term and set short and long-term goals," he said at a press conference.
Sharon condition
The developments come as coma-stricken Prime Minister Ariel Sharon suffered a fresh setback, just hours before he was to undergo skull surgery.
The 78-year-old leader suffered a massive brain haemorrhage three months ago, effectively ending his career, just months after breaking away from the Likud party and forming Kadima.
Surgeons were set to restore part of his skull, which was removed in initial surgery, but were forced to postpone their plans after he was found to have developed a slight infection in his respiratory tract. His condition has been described as "serious but stable."
Hamas ready with neighbours
Meanwhile in Gaza, one Palestinian was killed and nine others wounded when Israel launched a series of air raids on the Palestinian Authority headquarters.
Palestinian President Mahmoud Abbas was in the West Bank at the time, and later condemned the strikes, calling on the international community to intervene to stop what he called Israel's escalation.
Israeli military confirmed it had shelled areas of northern Gaza that it said Palestinian militants use for firing rockets into Israel.
Meanwhile, the Hamas-led Palestinian government said it is ready to live "side by side" with its neighbours, in a letter from the foreign minister to the United Nations Secretary General.
The letter, obtained by AFP, referred to a "two state resolution" for the ongoing conflict.
"We are looking for freedom and independence side by side with our neighbours and we are ready for serious discussions with the quartet," said a copy of the letter addressed to UN chief Kofi Annan.
The quartet, the EU, Russia, the UN and the US, are the sponsors of the stalled Middle East peace process.
"We look forward to living in peace and security, as all countries in the world, and that our people enjoy freedom and independence side-by-side with all our neighbours in this holy place," the letter added.