Israel's prime minister, Binyamin Netanyahu, has been forced to recalibrate his election campaign in response to a downward spiral in opinion polls due to a surprise challenge from an ultra-nationalist startup millionaire and veteran of Israel's most elite commando unit.

New tactics are expected to be in evidence on Sunday when Netanyahu appears at a youth rally, following the panicked cancellation of an event on Thursday after dismal turnouts at two campaign rallies earlier in the week.

On the advice of his campaign strategist, US Republican adviser Arthur Finkelstein, the prime minister will stop making direct attacks on Naftali Bennett, whose far-right Jewish Home party has gained unexpected momentum. Assaults on the 40-year-old Bennett have boosted his electoral appeal, analysts say.

Netanyahu will focus instead on extreme rightwing and ultra-religious members of Jewish Home who are in contention to gain parliamentary seats in the election on 22 January – dubbed by some as the "list of lunatics". Bennett has said his candidates are "the best of the best".

The battle on the far right of the political spectrum has rattled Likud-Beiteinu, the electoral partnership forged between Netanyahu and the rightwing former foreign minister, Avigdor Lieberman, at the start of the campaign. Netanyahu is reported to have shouted at party workers last week, and Finkelstein flew in from the US a week ahead of schedule to advise on how to staunch the loss of voters.

A Jerusalem Post poll on Friday forecast 32 seats for Likud-Beiteinu in the 120-member parliament, down from a total of 42 currently held by the two parties and from Finkelstein's forecast of 47 at the time of the merger. Jewish Home was on course to win 16 seats, putting it within spitting distance of becoming Israel's second-largest party, a position at present held by Labour, who are predicted to take 17 seats. The Post poll followed the pattern of numerous recent surveys showing Bennett's party steadily gaining at the expense of Likud-Beiteinu.

Analysts say Bennett's support is strongest among voters under 40. Around a third of those saying they will back Jewish Home, which is strongly identified with the religious right, define themselves as secular. "Bennett's success comes from being young and fresh and offering hope and change," said pollster Rafi Smith.

Gil Hoffman, chief political correspondent of the Post, said: "Bennett is seen as a cool guy and salt of the earth. You couldn't come up with two things more respected in Israel than hi-tech success and serving in Sayeret Matkal [the elite special forces army unit] – and Bennett has both."

The son of US immigrants, Bennett made $145m from selling his hi-tech startup before becoming Netanyahu's chief of staff for four years until 2008. His politics are far right, nationalist and religious. He believes Jews have a God-given right to the whole of Eretz Israel – which includes the West Bank, East Jerusalem and Gaza – and advocates the expansion of settlements.

According to Yedidia Stern of the Israel Democracy Institute, "a long-term change in Israeli society" underlies Bennett's immediate popularity. "More and more Israelis are strengthening their Jewish identity, not necessarily becoming more religious but becoming more connected to Jewish identity. We've seen it in academia and the media; now we're witnessing the political expression." The conviction among many Israelis that the Palestinians were unwilling to negotiate an acceptable peace settlement bolstered a belief that "we have to be strong. And to be strong in Israel means to be rightwing," said Stern.

Netanyahu remains on course to form the next coalition government and continue as prime minister, however. The rightwing bloc, including the small ultra-Orthodox parties, is expected to win 63-68 seats, giving it a majority, according to Smith. But if Jewish Home's success holds up, Bennett could find himself with powerful leverage in post-election horse trading and in contention to become a minister. However, Smith predicts the party could fall back in the polls over the next two weeks. "Bennett may have peaked too early. He will probably go down by a few seats unless Likud-Beiteinu continues with its misguided campaign against him. But he should still get 11-12 seats. Netanyahu knows he will still be prime minister, but may not succeed in his goal, which was to entrench and extend his power."

With just over two weeks to go before the election, 15-20% of voters are still undecided, said Smith.