Google was already seeing some criticism over blocking the video of Prophet Mohammad that has sparked the recent violence in Egypt and Libya. It only blocked the video in those countries, temporarily, but it did not pull down the video entirely and has no intention of doing so.
YouTube's argument is that the video itself is well within the confines of its terms of service, aka the Community Guidelines, and it has no reason to remove it.
The video is not considered hate speech since it's not directed at individuals but at a group.
Interestingly, after all of this, the White House actually got involved directly and asked YouTube to review the video.
It didn't ask it to remove the video, the US government hasn't gotten so obvious in ignoring freedom of expression and freedom of speech just yet, but it did ask the company to check whether it was within its Terms of Service.
Which, of course, YouTube already did and that's what it told the White House too. The site found the video to comply with the Community Guidelines and won't be re-reviewing since nothing has changed about the video.
However, YouTube did say that the video is now blocked in more countries than Libya and Egypt, it's also blocked in India and Indonesia as well as any other country where it would be considered illegal, which would be quite a few Arab countries.
The video will be staying up then, however, its creator, who was finally revealed to be Nakoula Basseley Nakoula, a Coptic Christian originally from Egypt, is under investigation for possible parole violation. He was out on probation since June after being sentenced for bank fraud two years ago. He has a much longer criminal record than this.