It was actually a pondered and restrained statement of intentions, delivered at the right moment, when the prospects opened by a cease-fire needed to be addressed by our government. The full text of the speech can be accessed at:
http://www.haaretz.com/hasen/spages/793308.html

and I’d heartily recommend reading it with attention because it contains a detailed statement of the policy Israel might pursue in the immediate future.

Addressing himself to the Palestinian people Mr. Olmert said:
“The terror, violence, murders and incessant attacks against the citizens of Israel are liable to lead us closer to a new and painful wave of terrible violence. The uncompromising radicalism of your terror organizations - the Hamas, [Islamic] Jihad, the Al-Aqsa Martyrs' Brigade and other organizations - did not bring you closer to attaining the goal which I am convinced many of you share - the establishment of a Palestinian state, which will guarantee you a future of prosperity and which will exist in good neighborly relations side-by-side with the State of Israel.

On the verge of making decisions which could plunge us into an increasingly escalating conflict, I come today, from here, near the tomb of David Ben-Gurion, to suggest to you a different path - a path which offers a chance for a different future, for you and for us.”

Then he proceeded to elaborate on the path to follow:
If a new Palestinian government is established - a government which will be committed to the principles of the Quartet, implement the road map and bring about the release of Gilad Shalit, I will invite Abu Mazen [Palestinian Authority Chairman Mahmoud Abbas] to meet with me immediately, in order to conduct a real, open, genuine and serious dialogue between us.

In the framework of this dialogue, and in accordance with the road map, you will be able to establish an independent and viable Palestinian state, with territorial contiguity in Judea and Samaria - a state with full sovereignty and defined borders.”

As to the “defined borders” he referred to President’s Bush letter to former PM Sharon (April 2004) which in its pertinent passage states:
As part of a final peace settlement, Israel must have secure and recognized borders, which should emerge from negotiations between the parties in accordance with UNSC Resolutions 242 and 338. In light of new realities on the ground, including already existing major Israeli populations centers, it is unrealistic to expect that the outcome of final status negotiations will be a full and complete return to the armistice lines of 1949, and all previous efforts to negotiate a two-state solution have reached the same conclusion.

To have mutually recognized secure borders require of course the dismantling of many settlements in the West Bank; in this context Mr. Olmert said:
We, the State of Israel, will agree to the evacuation of many territories and communities which were established therein. This is extremely difficult for us, akin to the Parting of the Red Sea, but we will bear it, in exchange for true peace.

He aptly ended with sentences which sum up the crossroads which both Israelis and Palestinians face at the moment:

The past cannot be changed, and the victims of the conflict, from both sides of the border, cannot be returned.

Dictates are futile and mutual accusations are nothing but useless word games. Historic scores cannot be settled and scars cannot be obliterated.

All we can do today is prevent further tragedies and bequeath to the younger generation a bright horizon and hope for a new life. Let us convert animosity and the "honing of our swords" to mutual recognition, respect and direct dialogue.

I think you underestimate the hopefullness of the Palestinians. They do believe that they will win! Militarily. They think they will win. Why? In part because of Lebanon. Moreso because they think that Israelis lack the will to win, and will flee the country en masse before suffering total war... or even if they do suffer it, that the damage will be done and Israelis will flee.