* Labour shifts gears to drive home economic message
* Netanyahu-led right-wing on re-election course, polls show
* Israeli centre-left failed to present united front
By Ori Lewis
JERUSALEM, Jan 16 (Reuters) - In decline since the peace it sought with the Palestinians unravelled into violence, Israel's Labour Party looks set to regain some lost ground in next week's election after waging an economy-focused campaign.
Opinion polls forecast an easy victory for conservative Prime Minister Benjamin Netanyahu in Tuesday's vote, which may push Israel further to the right, if as widely expected, he then enlists pro-settler and religious allies to his coalition.
But centre-left Labour, bolstered by public discontent with high living costs and the flagging political fortunes of the once-governing centrist Kadima party, seems poised for its strongest parliamentary showing in years.
Netanyahu has made Israel's security the main campaign issue of his right-wing Likud party, fielding a joint list of candidates with the ultranationalist Yisrael Beitenu party.
He has cited Iran's nuclear ambitions, civil war in Syria and a new Islamist government in Egypt as reasons why, as Likud's campaign posters say, Israel needs a "strong" leader.
While Netanyahu plays his security card, a revamped Labour Party is using economic and social issues to try to claw its way back, focusing on Israeli concerns about rising living costs.
Opinion polls forecast a respectable second-place finish for the centre-left party, now focused on pocketbook rather than peace issues, with talks on Palestinian statehood frozen since 2010 in a dispute over Israel's settlement-building policies.
Abraham Diskin, a political scientist at Jerusalem's Hebrew University, said Labour was also benefiting from a steep decline in support for Kadima, which won the most assembly seats at the last election in 2009, but failed to retain power.
Kadima was outmanoeuvred by Netanyahu, who became prime minister after drawing a clutch of right-wing and religious parties into a coalition with a big parliamentary majority.
Diskin attributed much of Kadima's election success in 2009 to former Labour voters. "They are now returning to the Labour Party," he said.
Some opinion polls predict that Kadima, now led by Shaul Mofaz, a dour ex-defence minister, will win no seats next week.
The party, a relative newcomer to politics and lacking a historical power base, was founded in 2005 by then-Prime Minister Ariel Sharon, who quit the Likud after a rebellion in its ranks over Israel's unilateral pullout from Gaza that year.
Labour, now led by a former journalist, Shelly Yachimovich, dominated the first three decades of Israel's statehood and forged interim peace deals with the Palestinians in the 1990s.
But an ultranationalist assassin killed its leader, Prime Minister Yitzhak Rabin, in 1995, Netanyahu won an election the following year after Palestinian suicide bombings, and a Labour return to power in 1999 was cut short when Ehud Barak failed to clinch a final peace accord and a Palestinian uprising erupted.
"Over years, the left was challenged by realities, not only by right-wing Israeli forces but by Middle East realities, and it never rose to the challenge," said political commentator Ari Shavit, who writes for the left-wing Haaretz daily.
"It is perceived by most Israelis as being totally irrelevant," he told Reuters.
However, unprecedented social protests in Israel in mid-2011 when hundreds of thousands took to the streets angered by high housing costs and soaring prices, gave Labour an opportunity.
Its election campaign has homed in on a struggling middle class. Under a photo of Yachimovich and the slogan "It can be better here", the party's website features a link to an economic plan it promises will narrow the gap between rich and poor.
It proposes higher taxes for the rich and for corporations and faster construction of affordable public housing.
Opinion polls show Labour taking up to 20 of parliament's 120 seats compared with about 34 for Likud-Yisrael Beiteinu. Labour won just 13 in 2009, a tally reduced to eight when Barak, now defence minister, and four others left the party in 2011.
Labour latched onto some bad financial news on Monday to contest Netanyahu's claim to be a skilful economic manager.
"Tell me how much longer he can keep calling himself Mr Economy," Yachimovich said after figures showed Israel's budget deficit had risen to 4.2 percent of gross domestic product last year, double the original estimate.
Labour candidate Erel Margalit, referring to Israel's high-tech prowess, also hammered home the economic message, saying: "Netanyahu turned the start-up nation into a stagnant nation."
Unlike other centre-left leaders, Yachimovich has pledged not to join a Netanyahu-led coalition.
Factions to Netanyahu's left also include two new centrist parties - Hatnua, led by Tzipi Livni, a former foreign minister and ex-Kadima chief, and Yesh Atid, headed by TV talk show host Yair Lapid.
Opinion polls predict eight seats for Hatnua and 11 for Yesh Atid. Livni's attempts to entice Yachimovich and Yesh Atid into a centre-left alliance failed, perhaps due to clashing egos.
Taking his own swipe at Netanyahu's economic policies, Lapid provided a bright moment in a generally lacklustre campaign when he publicly drew a red line through a cartoon depiction of a bomb listing price rises that have hit the middle class.
The stunt mimicked Netanyahu's own sketching of a red line through a cartoon bomb at the United Nations in September, when he said Iran was moving closer to a nuclear weapons capability.
While Labour, Yesh Atid and Hatnua compete for the political centre, the small Meretz party carries a torch for the left.
"We're not ashamed, we are a left-wing social democratic party, we are proud to be called left-wing," Nitzan Horowitz, a Meretz legislator, told Reuters.
The party, led by Zahava Gal-On, has three parliamentary seats and opinion polls show it may double that total next week.
Horowitz outlined the "three pillars" of Meretz's platform as separating religion and state, ensuring social justice and promoting peace between Israel and its Arab neighbours.
Meretz opposes settlement activity and says Israel should immediately recognise a Palestinian state along the lines that existed before the Jewish state captured the West Bank, the Gaza Strip and east Jerusalem in the 1967 Middle East war.