This is part of the churches movement to roll back a lot of Vatican 2 reforms.  After John Paul the 2nd and the Catholic Sex Abuse Scandal the church has actually become more conservative than actually address problems within their leadership.  Churches are starting to implement changes like Latin mass again or younger confession ages.  Instead of talking about social justice the church talks about right to life issues.  I see this issues as the church becoming more conservative again and being blind to what their actual parishioners believe. 

The church is operating under the assumption that people will just forgive the church or that people won't hold the church accountable for their actions.  They are trying to bring in people who are very conservative.  They are trying to bring in people who will be militant about preserving the religion, the irony of course being that they are losing membership.

That is my view from the catholic side.

Firstly, I think that the remarks of Bishop Williamson should not be mistaken for some widespread belief within Catholicism that the Holocaust didn't exist.  The very fact that Williamson and the entire Lefebrvists faction were only recently reinstated (and I don't think that they should have been) demonstrates how far outside the mainstream of Catholic thought they are.

Secondly, I am no defender of the hierarchy but it is entirely possible that they were unaware of Williamson's stance. They are kept in an incredible bubble.  Beyond that, the reason that the Lefebrvists were excommunicated had nothing to do with their stance on the Holocaust and everything to do with their stance on the authority of the Pope post Vatican II, and it is likely those are the issues that the Vatican were focusing on.

There is no defending Williamson's actions but focusing on Williamson's Holocaust-denial kind of misses the whole point of this event and why most Catholics should be upset about it.  At a time when Catholic reformers on the Left are being treated poorly, the Vatican determined to reinstate a sect that denies the authority of the Pope (see Michael Sean Winters recent article in Slate about the subject: http://www.slate.com/id/2210151/)

And that is how Williamson's remarks need to be understood - in terms of internal Catholic Church politics, whereby traditionalists who seek to undo the reforms of Vatican II wish to revert to an old order.  I suspect Williamson's anti-semitism comes from the same place as his traditionalism.

The funniest commentary on this comes from Stephen Colbert:

http://www.colbertnation.com/the-colbert-report-videos/217927/february-04-2009/yahweh-or-no-way---the-super-bowl (at minute 3).

"The Bishop believes that there's enough proof that 2,000 years ago a man rose from the dead but not enough proof that 60 years ago the Nazis were pretty bad"

I can identify with Maureen Fielder. I am a Catholic, and I am furious over this current display of idiocy by the Catholic leadership. Benedict, it seems, is more focused on maintaining Church unity than he is in maintaining strong interfaith relations. 
However, I must say that I am not surprised. Catholic leadership makes decisions and they expect their "flock" to follow without a murmur. They believe that they know what is best for their parishioners. Such sentiments do not match up with current ideals held by humans in developed countries, but the Church does not recognize this. The ultra-fundamentalists are much more in line with the doctrine of the Church than are the progressive Catholics. I think that, under Benedict, the Vatican will side with the fundamentalists. Under Pope John Paul II, the progressives had more of a voice. John Paul II was known for attempting to bridge the divides between Catholicism and other religions. In my opinion, John Paul II's focus was on the human community. He even apologized for historical wrongs done by the Church and Catholics. Such apologies are not frequently found in the history of Catholic leadership. (Note: don't hold your breath for an apology from Benedict over how all of this has gone down. I doubt he sees that he's done wrong. He might think he should have made a more diplomatic choice, but he won't backpedal.) Benedict's priority, however, seems to be in maintaining the Church. 
The Pope will, I believe, face a backlash from the international community. He has already had an unsuccessful conversation with Angela Merkle about this. Within the Church - well, things don't much change. It will not be addressed during Mass. Catholics who are not knowledgeable about world news will have this story pass them by and not care. Those of us who do notice may shrug our shoulders in a "there they go again" kind of defeatism. Personally, I will add this incident to a long list of things I see wrong and cannot reconcile myself to. However, I cannot see myself leaving the Church. It's difficult for those who are not Catholic to understand, but for many of us, once you are raised a Catholic, that is what you are. It's like my heritage: I can't change that my mother is Portuguese and English and that my father is French. I also cannot change that we are Catholics. There are parts of the religion I love - but I don't love how the Vatican and the Pope do these things time and again without changing. That I could live without. 

It was clear from the beginning that the appointment of this pope was going to cause problems.  As a child who spent his formative years in Nazi Germany, he appears to still be blind to his own bigotry.  Although he has been pope for only a relatively short time, he has already insulted both Muslims and Jews several times.  He has made several foot-in-mouth statements and taken the pains to reiterate an ancient papal encyclical condemning Muslims, all which belie how he really thinks.  He totally lacks the sense and sensitivity of his predecessor who had spent some time in a Nazi prison as a young man in Poland.

By reinstating this bishop, the pope gives this holocaust denier credence and status which Williamson would not have had he remained just another obscure member of a fringe group.  For the Vatican to demand a "retraction" is a very weak response followed by an even hollower statement by Williamson.

The problem here is this pope, not just this incident which will remain a sore point for many years to come.  In a time of great tension, this pope continually fans the flames of hatred, to the detriment of us all.