In the West Bank town of Bethlehem, the Biblical site of Jesus' birth, thousands of worshippers gathered to celebrate midnight Mass.
Local officials in Bethlehem say double the number of pilgrims have visited this year compared to last.
In Rome, Pope Benedict XVI celebrated a special Mass in St Peter's Basilica, watched by thousands of pilgrims.
Those who were unable to join the congregation filling the church watched the Mass on giant video screens in the square instead.
Nazareth Nativity
A new floodlit Nativity scene was officially unveiled in the square in front of the basilica. This year the larger-than-life-size statues of the baby Jesus and his family have been placed in a Nativity scene set not in a Bethlehem stable, but in a room in Joseph's house in Nazareth.
Vatican officials say the change was made to illustrate the notion that Jesus was born everywhere, not just in Bethlehem.
In his sermon Pope Benedict urged people to find time and space for God, the needy and the suffering.
On Tuesday at noon (1100 GMT) the Pope will deliver his traditional "Urbi et Orbi" Christmas message to the world from a balcony overlooking St Peter's Square.
Tourist revival
In Bethlehem fears about security and Israel's West Bank barrier - an imposing eight-metre (24-foot) concrete wall separating the town from Jerusalem - have discouraged potential visitors in recent years.
During the second Palestinian uprising, which started in September 2000, tourism collapsed. But with the relative stability of the last two years, tourists and pilgrims are returning to the town in larger numbers.
"Between 25 to 35,000 pilgrims and tourists are going to be around today and tomorrow - twice as much as last year... Today we have about 60 to 70% of the normal tourism and pilgrimage to the city," Victor Batarseh, the mayor of Bethlehem said.
"This year is much better than the last seven years for tourism," local shopkeeper Jacques Aman told Associated Press. "The atmosphere is better in general. There is relative calm, from the security standpoint," he added.
But the BBC's Bethany Bell says there are still far fewer tourists than there used to be before the uprising and that many of those celebrating outside the Church of the Nativity were local people.
There was still a heavy police presence, and before worshippers arrived bomb squads swept cars and buildings for explosives.
Message of peace
Christmas carols played to a crowded Manger Square, in front of the Church of the Nativity - built on the site of the stable where Jesus is said to have been born.
Palestinian President Mahmoud Abbas, a Muslim, joined the midnight Mass in Bethlehem and emphasised that not only Christians were celebrating the festival.
"The new year, God willing, will be a year of security and economic stability," he said. "We pray next year will be the year of independence for the Palestinian people," he added.
Latin Patriarch Michel Sabbah, the Catholic leader in the Holy Land, called for peace in the Middle East as he led the Mass.
"This land belongs to God. It must not be for some a land of life and for others a land of occupation and a political prison," he said in a sermon delivered in his native Arabic.
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