For the last year or so Arafat has been confined by the Israelis to his Muqata building in Ramallah. (Or, he could leave, but the Israelis wouldn't allow him to come back.)
The question of whether or not to exile Arafat is debated regularly in Israeli media. The argument against usually runs that Arafat, even outside the Palestinian territories, would still lead the terror war against Israel.
Finally, the Jerusalem Post offers a solution that would prevent Arafat from having any further contact with terrorists, (except maybe the ones who are done with their 72 virgins).