"This is the first time that the Israeli government has sat opposite the chancellor of Germany and a considerable part of the German government," Israeli Prime Minister Ehud Olmert noted as he opened the joint meeting.

Merkel said German-Israeli relations could only "remain special, when we create projects of the present and future." Olmert said that while Israel would not forget the past, it also would not "give up on the chance" to build with Germany a better "future of security, reconciliation, tolerance and peace."

At the session, the two countries signed a bilateral agreement, in which they resolved to intensify military, as well as political, cultural and economic cooperation.

Merkel, on her second day of a three-day visit marking 60 years since Israel was founded, earlier paid her respects to the six million Jews killed during World War II by touring Israel’s Yad Vashem’s Holocaust memorial site.

Accompanied by Olmert, seven German and eight Israeli ministers, a composed Merkel attended a memorial service for the victims of the Holocaust, laying a wreath and lighting an eternal flame at Yad Vashem’s Hall of Remembrance.

"In recognition of Germany’s responsibility for the Shoah (Hebrew for Holocaust), the German government underlines with the first German-Israeli consultations its determination for a joint shaping of the future," she wrote in Yad Vashem’s guest book, pointing to the inter-governmental consultations later in the day.

The two countries agreed to hold similar consultations on a regular basis, meeting next in Berlin in 2009. Germany has had such annual consultations only with European countries including France, Italy, Poland and Russia.

Merkel, who on arriving in Tel Aviv Monday and referring to Germany’s past, had already said Berlin had a "special responsibility" toward Israel, was also scheduled Tuesday to become the first German chancellor, and the first foreign head of government, to address the Knesset. Thus far, only a number of heads of state, including two German presidents and most notably Egyptian President Anwar Sadat in 1977, have addressed the Israeli parliament.

She was due to make her speech in German, sparking protests by two right-wing Israeli legislators.

Merkel also addressed ongoing Israeli construction in East Jerusalem, which has caused outrage among Palestinians, who claim the section of the city as their future capital.

She described such construction as a "problem" for the peace process with the Palestinians, and called on both sides to "meet their obligations" under the "road map" peace plan, which calls on Israel to freeze settlement construction and on the Palestinians to disarm and arrest militants.

Olmert however said that while he had ordered a freeze in Israeli construction elsewhere in the West Bank, Israel would continue to build in Jewish settlements in and near Jerusalem which it considered an "inseparable part" of the city.

"When we build in Jerusalem, and we are building in Jerusalem, everyone knows that there is no chance that the State of Israel will give up on a neighbourhood like … Har Homa," he told a joint news conference with Merkel, who also called Palestinian rocket attacks at southern Israel an "obstacle" to the negotiations.

Olmert also said Israel remained committed to the peace negotiations with Mahmoud Abbas, which were frozen by the Palestinian president following a deadly Israeli military operation in Gaza in response to a surge in the rocket attacks earlier this month. The sides’ chief negotiators, Israeli Foreign Minister Tzipi Livni and former Palestinian premier Ahmed Qureia, were to meet later Monday – their first parley since the high Gaza death toll, Olmert said.

The Israeli premier said a large part of his talks with Merkel focussed on Iran. Both Germany and Israel viewed Iran’s move toward nuclear armament "with serious concern" and believe this move should be blocked, he said.

Germany and Israel established diplomatic ties in 1965 after years of negotiations that included reparations for Jewish property lost and looted during the Holocaust. A year later, former German chancellor Konrad Adenauer visited former Israeli prime minister David Ben-Gurion at his kibbutz of Sde Boker in southern Israel, which for its symbolism was chosen as Merkel’s first stop on her current tour. Israel currently regards Germany as its closest ally in Europe.

DPA with Expatica