(Adds Israel confirms deal signed, exhumation begins)

BEIRUT, July 7 (Reuters) - Israel and Hezbollah have signed a U.N.-mediated prisoner exchange deal and the date for the swap will be settled this week, a Lebanese political source and the Israeli prime minister's office said on Monday.

The Lebanese source said Hezbollah leader Sayyed Hassan Nasrallah and Israeli Prime Minister Ehud Olmert had both signed the deal under which the Jewish state will release five Lebanese prisoners and Hezbollah will hand over two Israeli soldiers.

Hezbollah seized the soldiers -- army reservists Ehud Goldwasser and Eldad Regev -- during a cross-border raid that triggered the 2006 war between the Iranian-backed group and Israel. Hezbollah has given no word on their condition, although they are widely presumed dead.

The Lebanese source said he expected the exchange to take place by the middle of next week.

"We expect the deal to move ahead, and it is possible we will have Regev and Goldwasser back in Israel next week," a senior Israeli government official in Jerusalem said.

The Israeli government statement said the completion of the deal still depended on the a number of components being finalised, after which Olmert's cabinet would vote to give it final approval.

Under the deal, which was negotiated by a German intelligence officer, Israel will also hand over the bodies of around 200 Arabs killed while infiltrating northern Israel while Hezbollah would return body parts of Israeli soldiers killed in south Lebanon in 2006.

The dead include Palestinian and Lebanese guerrillas killed in decades of conflict with Israel and the bodies of eight Hezbollah fighters.

An Israeli army spokeswoman said the exhumation of bodies began on Monday and that it would take a number of days to complete the process.

The Lebanese prisoners include Samir Qantar, the most prominent held by Israel. He is serving a life sentence for killing a policeman as well as a man and his 4-year-old daughter during a 1979 raid on the northern coastal town of Nahariya.

Nasrallah said last week he expected the exchange to take place around the middle of the month. (Reporting by Laila Bassam, additional reporting by Ori Lewis in Jerusalem; Writing by Tom Perry; Editing by Ibon Villelabeitia)

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