Thousands of worshippers packed the basilica for the midnight service, with giant video screens set up in Saint Peter's Square for those unable to enter.
"Let us pray that peace will be established ... that hatred and violence will cease. Let us pray for mutual understanding, that hearts will be opened, so that borders can be opened."
Pope Benedict XVI
In Bethlehem itself, Wednesday night saw thousands of pilgrims join celebrations in Manger Square, the site where Christians believe Jesus was born.
They were overseen by around 500 security personnel despatched from the cities of Ramallah and Jericho to protect visitors over the Christmas holiday.
"We expect about 40,000 visitors in Bethlehem this week," said Khouloud Daibes-Abu Dayyeh, the Palestinian Authority's minister of tourism.
The estimate included Christians from the West Bank, the Gaza Strip, Israel and the rest of the world.
About 900 Christians from Gaza applied for Israeli permission to travel to Bethlehem for the Christmas celebrations, but only about 300 received authorisation.
In May Pope Benedict is expected to visit Israel and the Palestinian territories in the first papal trip to the region since his predecessor Pope John Paul II travelled there in a 2000 pilgrimage.
In his homily to worshippers in the Vatican, Pope Benedict also sent out an appeal for children around the world who are abused, exploited, forced to live on the street or serve as soldiers.
|About 40,000 visitors are expected in the West Bank town of Bethlehem this week [EPA]
"The Child of Bethlehem summons us once again to do everything in our power to put an end to the suffering of these children," he said.
Delivering his homily in Italian, he pointed to the plight of "street children who do not have the blessing of a family home, of those children who are brutally exploited as soldiers and made instruments of violence, instead of messengers of reconciliation and peace."
He also spoke of minors who are "victims of the industry of pornography and every other appalling form of abuse, and thus are traumatised in the depths of their soul."
He did not however specifically mention the issue of lawsuits and other complaints brought in the US and elsewhere by Catholics who allege they were sexually abused by priests when they were youngsters.