I just had my attention turned to this thread by EvolvedSaurian, who seems embarrassed by it. He was a wee little teen back when this was posted.
The Kimberley Proposal, proposed by the guy, comes to mind
http://en.wikipedia.org/wiki/Isaac_Steinberg
The wholesale massacres and epidemics have largely ended by the time of the proposal. However it was also the time where the policies of A O Neville, Chief Protector of Aborigines, were gathering steam. Child abduction and the building of concentration camps were prominent during this time. Perhaps the establishment of this "Israel" would curb the effect of these policies, it depends on how much autonomy the Jewish settlers are given by the Commonwealth. I however don't see the Aborigines faring that much better.
Speaking of the Kimberleys and Aborigines, @
DMA: I've recently been reading on Jandamarra and the Bunuba resistance. Enthralling stuff, one wonders if you'd be interested in reading on it or if you have already read about it.
One potential positive thing I see out of this is possibly a more intense development of the Northwest, in terms of infrastructure and agriculture. If this "Israel" attracts the same number of skill workers and scientists that OTL Israel did, there would be a lot of benefits. It would be curious to see how the Ord and Fitzroy Rivers will be utilised. It could a major foodbowl.
As people have mentioned before, more space, less hostile neighbours, more resources. It would seem to be a setting for a more prosperous Israel, especially when the huge iron deposits are discovered.