I'm not sure this is as big deal as it sounds on first reading. 'Diplomatic relations' is a step down from 'Full Diplomatic Relations'. I am pretty sure that Israel has diplomatic relations with many Arab countries. I seem to remember visiting the Egyptian Consulate in Tel Aviv once to sort out paperwork prior to a trip down the Sinai. Even where direct consular presence is not in place, arab countries have diplomatic relations established through freindly proxy.
I would be interested in understanding how far the Israeli's want to go with this. If they are talking about setting up full embasseys and their ambassadors presenting credetials to the head of state then that would be something!
Only Egypt, Qatar & Jordan have diplomatic relations with Israel. And offering hand of friendship is something and accepting that hand is something else. Israelis offer hand of friendship but we have to wait to see if Iraqis can accept it or not.