JERUSALEM, July 25 (Reuters) - Israel and the United States have signed an agreement to make the Arrow II ballistic shield capable of shooting down missiles at a higher altitude, the Israeli Defense Ministry said on Sunday.

The Arrow III will allow Israel to deal with the threat of ballistic missiles with long range and will give it the ability to shoot down weapons of mass destruction outside the atmosphere, the ministry said in a statement.

Israel, which describes its Arrow system as a defense against Iran, says the upgraded version will cap off its multi-tier air defences.

The Arrow is jointly produced by state-owned Israel Aerospace Industries and the American firm Boeing Co. and has absorbed close to $1 billion in direct U.S. funds since its 1988 inception.

The Israeli air force said last year that the Arrow III would take more than four years to complete and that would depend on what resources were made available for the project.

The United States, Western powers and Israel suspect Iran's civilian nuclear program is designed to produce a nuclear bomb. Tehran denies this.

Israel, which is assumed to have the Middle East's only atomic arsenal, has hinted it could resort to force to prevent Iran attaining the nuclear means to threaten its existence.

Iran has threatened to retaliate for any attack on its nuclear facilities by firing medium-range missiles at Israel. (Reporting by Dan Williams; Writing by Joseph Nasr, Editing by Alison Williams)