Inside the church, monks chanted as pilgrims quietly waited in line to pray.
"This is the place where God gave us his son, so it is very special for me to be here, for me and my whole community," said Juan Cruz, 27, from Mexico.
"It's safe, it's warm, it's a happy time. It's good for visitors to see the good things too," said 16 year-old Bethlehem resident Reem Mohammad.
Calls for prayers
The celebrations culminated with midnight mass in the adjoining St Catherine's church, where the leading Roman Catholic cleric in the Holy Land called on the faithful to pray for peace in the troubled region.
"I address myself to all believers throughout the world, and I urge them to pray for this Holy Land. It is a land that suffers and that hopes," Fuad Twal, the Latin Patriarch of Jerusalem, said.
He said true peace would not come to the Holy Land until Israelis and Palestinians treat each other with respect.
"Its inhabitants are brothers who see each other as enemies," he told the gathering that included Mahmoud Abbas, the Palestinian president.
"This land will deserve to be called holy when she breathes freedom, justice, love, reconciliation, peace and security."
The celebrations cap a year when tourists returned to the town in the Israeli-occupied West Bank, in numbers unseen since the outbreak of Israeli-Palestinian violence at the turn of the century.
Khulud Duaibess, the Palestinian tourism minister, said more than 1.6 million people have visited Bethlehem this year, 15,000 pilgrims for Christmas alone.
In 2008, one million tourists visited the town.
Shadow of the wall
However, the tourism boom has not brought prosperity to Bethlehem, with most tourists whisked in for the day from hotels in Israel, Duaibess said.
|Christmas celebrations continue to be hampered by the separation wall [AFP]
"Only five per cent of the money stays on the Palestinian side," she said.
Mitri Raheb, a Lutheran pastor in Bethlehem, told Al Jazeera that visitors to the town do not stay for long because of the Israeli occupation, and that has hurt the economy.
The Christmas celebrations have provided only a respite from the shadow of the wall lurking over the entrance to the West Bank town, part of Israel's controversial separation wall.
The eight-metre high concrete barrier that separates Bethlehem from Jerusalem - part of the projected 700km West Bank barrier, is aimed at stopping attacks from Palestinian fighters, Israel says.
Palestinian residents and rights groups call it an "apartheid wall" that cuts them off from much of their land and hampers tourism, trade and freedom of movement.
As Raheb said, for Palestinians, it is "very hard to see a light at the end of the tunnel".