However, Netanyahu still faced a political crisis with coalition allies threatening to bolt his government and his personal reputation and credibility damaged.
"The decision is to close - for lack of sufficient evidence - the case against the prime minister," Attorney General Elyakim Rubinstein told a news conference.
Rubinstein said evidence provided by police did suggest that Netanyahu might have appointed Roni Bar-On as attorney general to satisfy a coalition ally who is facing a corruption trial.
Netanyahu's actions "raised puzzling questions," he said. "From the evidence there is suspicion that there were other (than legitimate) considerations" in the appointment. "But we don't think this can be proved beyond a reasonable doubt."
Rubinstein also rejected a police recommendation to indict Justice Minister Tsachi Hanegbi. He said prosecutors still were weighing charges against Arieh Deri, leader of the ultra-Orthodox Shas Party, who is suspected of trying to engineer the appointment of Bar-On in exchange for a plea bargain that would keep Deri out of jail. Israeli media had reported an indictment against Deri was certain.
Rubinstein said that Netanyahu's top political aide, Avigdor Lieberman, and a contractor who is close to Netanyahu, David Appel, would face further investigation.
Netanyahu admitted yesterday that he had made mistakes and vowed to clean up the process of wheeling and dealing that has surrounded the appointment of senior officials.
"The bottom line is this: I committed no crime, and the attorney general confirmed this," Netanyahu said in a televised address to the nation.
"It's clear to me today that we must improve the process of choosing senior officials," he said. "But there is a big difference between a mistake and a crime. I will learn the lessons and implement them."
Opposition Labor Party officials said Netanyahu would find it difficult to govern in the wake of the criticism of his conduct.
"Every honest person must ask himself if he accepts the moral authority of a man who is not on trial only because ... there is insufficient evidence," said Ehud Barak, the leading candidate to take over as Labor Party leader this summer.
"I fear the prime minister will find it very difficult to function."
Yossi Sarid, head of the liberal Meretz Party, said he would ask the Supreme Court to overturn the prosecutors' decision and force Netanyahu's indictment.
A government official close to Netanyahu, who spoke on condition of anonymity, said the prime minister received an advance copy of the report and reviewed it with his aides and his attorney.
The official said the language used in reference to Netanyahu was "very mild," accusing the prime minister of "failing to internalize" warnings he received against appointing Bar-On in January.
The prosecutors were harder on Deri.
"We are uncomfortable, to say the least, that a lawmaker ... accused of criminal acts involves himself in selecting (the attorney general)," Rubinstein said.
Shas lawmaker Shlomo Benizri said if only Deri is indicted, it would increase tensions between the half of Israel's Jews who are of Sephardic, or Middle East and North African, background - the party's constituency - and Israelis of European background. "It could bring about violence," he said.
In its report breaking the story of the scandal three months ago, Israel Television said Deri traded his support and his party's vote for Israel's withdrawal from Hebron for an attorney general.
Deri's Shas Party reportedly was planning to meet later yesterday to discuss whether they would remain in Netanyahu's coalition.
AP PHOTO
Orthodox Jews demonstrate yesterday outside the Justice Ministry in Jerusalem to show their support for Israeli Prime Minister Benjamin Netanyahu.