By Rebecca Harrison

JERUSALEM, May 8 (Reuters) - Israel celebrates its 60th birthday on Thursday with barbeques and a Bible quiz, but the party is tainted by an investigation that could unseat the prime minister and derail efforts for a peace it has never known.

Fireworks and military fanfare launched celebrations on Wednesday evening and Prime Minister Ehud Olmert, who is pursuing a statehood deal with the Palestinians, said Israel "craved" an end to the decades-old conflict.

Boasting a thriving economy, Israel will showcase its achievements with concerts, parties, an airforce aerobatic displays as well as a youth bible quiz that highlights the place of religion in what is largely a secular state. Israel's most important ally and the chief sponsor of peace talks launched six months ago, U.S. President George W. Bush, visits next week. So do top executives from Google and Yahoo -- testament to Israel's success as a technology powerhouse.

"We have created a future for ourselves which surpasses our dreams," President Shimon Peres was quoted as saying in the German newspaper Bild on Thursday.

Israel will celebrate under tight security, for fear of militant attacks.

Palestinians will hold solemn marches marking the "catastrophe" of the Jewish state's creation in 1948 when about 700,000 of their compatriots fled or were driven from their homes.

Palestinians have lived under occupation in the West Bank since a 1967 Arab-Israeli war and are now seeking to negotiate creation of their own state as part of a settlement with Israel.

The festivities are clouded by a police investigation into Olmert's affairs that has stoked speculation he may have to quit, upsetting peace talks already beset by squabbles over Jewish settlements and violence in the Hamas-run Gaza Strip.

OLMERT PROBE

Already the focus of a series of corruption scandals in which he has denied any wrongdoing, Olmert was interrogated at short notice by police on Friday over fresh allegations.

A court order has censored details of the suspicions, but Israeli media quoted police officials as saying that reporting restrictions could be lifted on Thursday evening.

A Palestinian negotiator on Wednesday said a resignation by Olmert would delay any agreement on creating a Palestinian state alongside Israel. Bush hopes to broker a deal this year.

Washington said Olmert was a "very important" player in the peace process but noted he was not Israel's only representative. Foreign Minister Tzipi Livni, seen as the likeliest successor to Olmert within his Kadima party, leads Israel's negotiating team.

"I can't comment on the internal investigations that are going on within the Israeli system," Stephen Hadley, President George W. Bush's national security adviser, told reporters.

Founded partly on the basis of Jewish claims to biblical land and partly as a haven for survivors of European persecution that culminated in the Holocaust, Israel declared independence on May 14, 1948.

Israelis celebrate the day according to the Jewish calendar. (Additional reporting by Brenda Gazzar in Jerusalem, Dave Graham in Berlin; Editing by Ralph Boulton)

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