By Crispian Balmer

JERUSALEM, Dec 3 (Reuters) - Feeling vindicated but vulnerable, Israel is preparing for a more precarious future with neighbour Egypt where Islamist power appears to be a rising tide forecast by Israeli leaders at the beginning of Arab unrest 10 months ago.

Already preoccupied with the nuclear ambitions of Iran, the widely predicted electoral triumph for mainstream and ultraconservative Islamist groups in Egypt has strengthened the sense of encirclement in the militarily powerful Jewish state.

Ministers have stayed silent about the vote, but Prime Minister Benjamin Netanyahu has already made clear that Israel may soon have to increase defence spending to face the challenge of growing Islamisation across the Arab world.

"The government is obviously very worried by what it has seen since the start of the Arab Spring," saidShlomo Brom, a senior researcher at the Institute for National Security Studies at Tel Aviv University.

"When Israelis think of Islamic governments, the model they see in their eyes is the Islamic Republic of Iran," he said, adding that it was far from clear how an Egypt controlled by the Muslim Brotherhood would look.

Founded in 1928 and long seen as Egypt's most organised political force, the Brotherhood talks the same language as other reformists when it comes to the need for democracy, and independent judiciary and social justice.

But its critics say such language masks the group's goal of turning Egypt into an Islamic state by stealth.

Israel's regional strategy is underpinned by its 33-year-old peace deal with Egypt, enabling the country to scale back dramatically its military budget and helping it maintain the status quo in its troubled relations with the Palestinians.

Egypt under ousted former president Hosni Mubarak also provided Israel with 40 percent of its gas needs and played a vital role in limiting the supply of weapons to the Islamist group Hamas, which rules the Palestinian Territory of Gaza.

"To have the biggest Arab country taken over by the Muslim Brotherhood is not good news. They will be more hostile, but not to the point of breaking the peace deal," said Uri Dromi, a spokesman for former Prime Minister Yitzhak Rabin.

Some elements of the relationship have already sagged. The gas pipeline has been repeatedly blown up in an increasingly lawless Sinai, the Israeli embassy in Cairo was mobbed by protesters in September and Egypt's ties with Hamas are warming.

DEMONS

Israel urged the United States to do more to bolster Mubarak in his final days, and resentment still lingers over the West's perceived failure not to have propped up his unpopular regime.

"All the demons have come out now," wrote Guy Bechor, head of the Middle East Division at Israel's Interdisciplinary Center Herzliya, predicting growing extremism across the region.

"The strong Israeli economy has enormous weight. It makes it possible for us to arm in such a way that no Arab side can afford to, and it is the almost sole guarantee for our stability," he added in an uncompromising analysis.

Following the deaths of eight Israelis in a cross-border attack by militants in August, the government has already decided to speed up plans to build a security fence along the length of its 266-km (165-mile) desert frontier with Egypt.

As tensions with Iran grow ever higher and neighbouring Syria sinks ever deeper into violence, Netanyahu has warned that more money might be diverted into the defence budget, which accounts for a substantial seven percent of the economy.

"The security threats to Israel are growing and soon we will need to decide about the defence budget, both in order to strengthen active defence systems ... and to strengthen physical defences," he told a parliamentary committee last month.

A jittery Israel is also at pains not to aggravate the Arab world, however, going as far as to delay demolition of a rickety footbridge at Jerusalem's holiest and most volatile religious site, fearing the work could spark Muslim anger.

"There were reports in the Egyptian media that if Israel were to undertake unilateral steps, that the hate at Tahrir Square would be turned against (Israel)," an Israeli official said this week, referring to Cairo's main public protest site.

NEW WORLD ORDER

Hamas, viewed as a terrorist group by Israel and much of the West, predicts that with its ideological partners gaining significant ground in Egypt, Israel and the world will have to be much more receptive to Islamist sensitivities in future.

"The Hamas movement feels revived today," said group spokesman Fawzi Barhoum, arguing that if the international community was ready to work with Egypt's Muslim Brotherhood, then it could no longer justify snubbing Hamas.

"Today the world should open a new chapter in dealing with Hamas movement," he said, predicting that moderate Islamist groups that were gaining ground across North Africa would strengthen the position of the Palestinian movement.

Rather than accommodating Hamas, Western allies want Israel to take bold steps towards peacemaking with Palestinian President Mahmoud Abbas, whose secular Fatah movement is looking increasingly out of place in the changing Arab order.

In an unusually blunt public statement on Friday, U.S. Defense Secretary Leon Panetta urged Israel to get back to the "damn" negotiating table and take steps to address what he described as its growing isolation in the Middle East.

Peace talks between the Palestinians and Israelis broke down last year in a dispute over continued Jewish settlement building in the occupied West Bank. Repeated U.S. efforts to break the deadlock have failed, with Netanyahu refusing to bow to a Palestinian demand that he halt the construction work.

Senior INSS researcher Brom said with Egypt's election process underway, Israel should try and seize the initiative.

"It can't just sit and wait. There are no guarantees that we can get an agreement, but we have to show the Arab Street that we are making an effort," he said.

But such a move looks unlikely, with a significant slice of Israeli society increasingly downbeat about striking a land-for-peace deal with Palestinians given the rise of political Islam.

"Why establish now yet another Arab country, when its sister countries are all disintegrating one after the other? The Arab Spring came along and buried the idea of a Palestinian state," said Herzliya's Bechor. (Additional reporting by Phil Stewart in Washington, editing by Rosalind Russell)