Ehud Barak said that while military action was a last resort, his country had proved in the past it would not hesitate when "its vital security interests are at stake."
"Currently, the focus is international sanctions and vigorous diplomatic activity, and these avenues should be exhausted," Mr Barak said.
But he added: "Israel is the strongest country in the region and has proved in the past it is not afraid to take action when its vital security interests are at stake."
The comments came after Iran conducted military exercises, launching a second round of Shahab 3 ballistic missiles in as many days. With a range of 1,250 miles, the missiles can hit Israel.
In response to Iran's war games, Secretary of State Condoleezza Rice warned that America would not back down in the face of threats against Israel.
Closing a three-day European trip in Georgia, Miss Rice said: "We are sending a message to Iran that we will defend American interests and the interests of our allies.
"We take very, very strongly our obligations to help our allies defend themselves and no one should be confused about that," she said.
She linked the first round of the Iranian missile tests to US plans for a missile shield based in eastern Europe, which would theoretically offer protection against missiles launched from Iran.
Such a shield "will make it more difficult for Iran to threaten and ... say terrible things, because their missiles won't work," Miss Rice said.
However she conspicuously stopped short of issuing a direct threat to Tehran, and US Defence Secretary Robert Gates said on Wednesday that there had been a "lot of signalling going on" in the escalation of rhetoric but he added he did not think confrontation was any closer.
In Israel, the Iranian tests were received with dread. Fears have raised that Iran will soon reach a point of no return in its quest for nuclear weapons.
The Iranian president, Mahmoud Ahmadinejad has often called for Jews to be removed from Israel, though he recently dismissed the idea of an Iranian strike on the Jewish state.
Earlier this week, British and American warships wrapped up Persian Gulf exercises on defending key petroleum installations, in case of conflict, and last month Israel held a major training exercise over the Mediterranean widely seen as a dress rehearsal for a pre-emptive strike on Iran.
Both, military experts say, have likely encouraged Iran to show off its own capabilities.
Ephraim Halevy, a former director of the Mossad, Israel's foreign intelligence service, told The DailyTelegraph that the missile testing signals that crisis is nearing a peak.
"Both sides, Israel and the West on one side and Iran on the other, are engaged in one-upmanship in anticipation of this crisis breaking, and it can break in either direction," he said.
"I think the breaking point is approaching. There comes a moment where you say we have exhausted our abilities to make proposals and that's it. And I think Iran also understands this."
Western nations last month proposed assistance for a civil nuclear programme and other economic incentives in exchange for a freeze on Iran's uranium enrichment activities. Iran has invited further negotiations led by EU foreign policy chief Javier Solana, leading Washington observers to conclude that it is either biding its time until the Bush administration ends in January 2009, or is genuinely divided about how to proceed.
Suzanne Maloney, an Iranian expert at the Brookings Institution, a leading think tank, said: "Last week the buzz was Iran is being more receptive. This week the buzz is sabre-rattling is intensifying. This is something of a certain pattern in US-Iran relations, and it seems the Iranians are hedging their bets."
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