The nearby Church of the Nativity sits on the spot where Jesus is said to have been born.
Meanwhile in St Peter’s Basilica in Rome, Pope Francis celebrated his first Christmas Eve Mass since becoming pontiff.
He earlier made a visit to Pope Emeritus Benedict, 86, and said he found his predecessor looking well.
The number of visitors to Bethlehem has been steadily rising in recent years as peace talks to resolve the Middle East conflict have resumed.
Despite the erection of Israel’s separation barrier with the West Bank – which appears as a high concrete wall around the town – three gates have been opened for Christmas to allow the Christmas procession led by the Latin Patriarch coming from Jerusalem to enter the city, says the BBC’s Yolande Knell in Bethlehem.
“The message of Christmas is a message of peace, love and brotherhood. We have to be brothers with each other,” said Latin Patriarch Archbishop Fouad Twal – the most senior Roman Catholic cleric in the Holy Land – as he arrived in town.
His motorcade crawled through Bethlehem’s narrow streets as he stopped to greet visitors.
It took Archbishop Twal nearly 90 minutes to make the short trip to the Church of the Nativity, where thousands of people were gathered ahead of Midnight Mass.
In Vatican City, a life-sized nativity scene was unveiled in the centre of St Peter’s Square.
The BBC’s Alan Johnston in Rome says thousands of worshippers from across Italy and around the world queued on a cold clear night before entering St Peter’s.
As soaring music filled the air, Pope Francis made his entrance and moved slowly up the central aisle, followed by a retinue of clerics.
In a short homily, Francis said that every Christian can choose between darkness and light, between love and hate.
“If we love God and our brothers and sisters, we walk in the light; but if our heart is closed, if we are dominated by pride, deceit, self-seeking, then darkness falls within us and around us,” he said.
On Christmas Day, Francis will deliver his Christmas message from the basilica’s central balcony overlooking St Peter’s Square.