The sudden move was seen as an attempt to shore up support for a two-state solution to the conflict with the Palestinians.
Sharon has been at odds with Likud conservatives, who tried to block the summer's Gaza pullout. In a terse letter to Likud's acting chairman, Sharon wrote: "I am resigning from the party and forming a new one."
Several Likud members announced that they will join Sharon in the new party, reported to be called National Responsibility, according to the Associate Press.
Public Security Minister Gideon Ezra said Likud rebels opposed to Sharon's peace negotiations forced the prime minister's action.
"I think that it is not an easy day. I had hoped that this wouldn't have to happen, that we would all remain together," Ezra told Israel Radio. "I had hoped ... that the members would say we are all falling into line, but that didn't happen, and Ariel Sharon decided what he decided, and I am going with him."
But others said they would try to block Sharon's plans. "The prime minister and his people are exerting great pressure on Likud legislators to defect from the Likud," party faction leader Gideon Saar told Israel Army Radio. "I call on Likud members ... don't give your hand to bringing down the Likud and to a process whose only purpose is a very deep withdrawal from the West Bank."
Acting Likud Chairman Tzahi Hanegbi said the party would elect a new leader as quickly as possible. Former Prime Minister Benjamin Netanyahu, who left the government in protest of the Gaza pullout, is the top contender.
Palestinian negotiator Saeb Erekat likened the events to the eruption of a volcano.
"I've never seen anything of this significance," he said. "I hope that when the dust settles, we will have a partner in Israel to go to the endgame, toward the end of conflict, toward a final agreement."
Sharon said his new party would adhere to the U.S.-backed "road map" peace plan, which outlines the steps necessary to negotiate the borders of a future Palestinian state, however, Sharon has maintained that Israeli troops would not withdraw from the entire West Bank.
Sharon asked President Moshe Katsav to dissolve parliament, a step that would move the vote from November 2006 to the beginning of March.
"Of course, I think we need to dissolve the Knesset and hold elections as soon as possible," Katsav said.
The political turmoil was sparked by a vote by the moderate Labor Party Sunday to pull out of Sharon's coalition, effectively breaking up a workable majority. Labor recently changed leaders when fiery union boss Amir Peretz defeated Shimon Peres in a party vote Nov. 10.
One poll Monday indicated that an alliance of Sharon's new party with the Labor and leftist parties would command a comfortable majority in the 120-member parliament, Reuters reported.
Meanwhile, Palestinians also are facing a turbulent parliament election Jan. 25 that pits the Islamic militant group Hamas against Prime Minister Mahmoud Abbas.
Sharon has said he would not hold talks with any Palestinian government that includes Hamas members.