It's beyond the point where religion has any say in it. It's "us" vs. "them". Personally, I think the Palestinians need to grow up. Israel has the biggest, meanest army out there, now that Iraq was defeated. Blowing up school children is not the way to get a country of your own. It can only lead to Israel using that army. They aren't going to say, "Gee, you killed our children, here's half our country."
I could suggest some ways I think the problems could be solved but that's too arrogant. I don't live there so anything I say will be just an ignorant, half baked idea. That said, my dumb idea is to completely remove the terrorist groups (through violence, mass arrests, whatever), give the Palestinian people full citizenship, and work it out in the Israeli Senate peacefully. Turn the situation from Israel vs. Palestine into Israel and Palestine vs. the terrorists who threaten progress. There has to be some way to allow the voice of reason to prevail and turning both peoples against the violence is the best way. They won't get a country immediately of course but it will be the first step in the right direction.