The conflict appears to be escalating in Israel:

Israeli aircraft sent missiles tearing through the office of Palestinian Prime Minister Ismail Haniyeh on Sunday in an unmistakable message to his ruling Hamas group to free an Israeli soldier.
Defense Minister Amir Peretz told a Cabinet meeting that Israel would go after “higher-caliber targets” in the future – a reference to senior Hamas officials inside and outside the Palestinian territories, a high-ranking political official said.
Israeli aircraft, tanks and naval gunboats have been pounding Gaza for the past week in an effort to win the freedom of Cpl. Gilad Shalit, who was seized in a cross-border raid that left two comrades dead. Thousands of troops also were sent into the coastal strip for Israel’s first ground invasion since quitting Gaza nine months ago.
[…]
“We will strike and will continue to strike at (Hamas’) institutions,” said Bar-On, an Olmert ally. “They have to understand that we will not continue to let them run amok.”
Hamas, whose charter calls for Israel’s destruction, took power after winning January parliamentary elections. The group is not monolithic, has a military wing and a political wing, and its political leadership is divided between more moderate elements in the West Bank and Gaza, and the more radical top leadership based in
Syria.
[…]
In other airstrikes after midnight, Israeli aircraft hit a school in Gaza city and Hamas facilities in northern Gaza, where a Hamas militant was killed and another wounded, Palestinian officials said. The military said they were “planning terror attacks against Israel.”
[…]
On Saturday, Hamas demanded the release of more than 1,000 prisoners held by Israel, but Israel rejected that out of hand.
Olmert again said Sunday that Israel would not yield to Hamas’ demands.
“Israel doesn’t intend to give into blackmail of any sort,” Olmert told his Cabinet. “Giving in today would be an invitation to the next act of terror.”
Hamas government spokesman Ghazi Hamad urged Israel to be more flexible.
“I think that if the Israeli government will understand that it’s possible to release prisoners, things will end OK,” Hamad told Army Radio. “If not, I think the situation will be very difficult for us and for you, too. … Maybe there will be a (military) escalation and people will die.

But is that true? If Israel did what the terrorists wanted, would this end, would they let the soldiers go and not kidnap anymore soldiers? Not according to this report:

An attempt to kidnap soldiers for the purpose of holding bargaining chips for the release of Palestinian prisoners was thwarted two and a half weeks ago, security officials said Sunday.
Two members of the Popular Resistance Committees were arrested trying to infiltrate Israel via Egypt in order to carry out the kidnapping. In their interrogation by the Shin Bet, the terrorists said they were sent by Jamal Abu Samhadana, head of the PRC in Gaza, who was killed in an Israel Defense Forces attack about a month ago.
Samhadana ordered Atzar to bury the soldiers after the kidnapping in orchards in the Rishon Lezion area, and instructed him to transfer information about the soldiers via fax or a messenger in order to take responsibility and to carry out negotiations for trading prisoners.
[…]
Before setting out for his mission Atzar underwent training in firearms and grenades (his trainer was later killed by an IDF strike on his training camp).
Security officials say the Resistance Committee has not ceased carrying out severe terror attacks against Israel, and has ignored the “calm” period.

Israel will not negociate with terrorists because they know what type of people they are dealing with. Why negociate with mass murders? Do you think they would be honorable and keep their word?
(Link to the above article via Israel Matzav)