While you are right in that using nuclear weapons would just make the muslims more determined in killing them, they are certainly fulfilling a critical function: They deter the Arab states from posing an existential threat to Israel and may have played an important, if unsaid, role in the two peace treaties Israel now has with its neighboring states. The Arabs by now all know that while Israel cannot possibly kill all Arabs, they could reduce thousand of years of history to rubble, including Mecca. And while their feelings toward Jews haven't changed a bit, they just aren't willing to pay that price, thank god. And I might remind you that Israel did not use them during Jom-Kippur war, so they certainly see it as a last resort.
First refugees travelling on Hungarian bus arrive at Austrian border (Reuters)
from the article: Report: Nixon feared Israeli nukes would spur arms race