Before the celebrations began, Israeli authorities said three Palestinians involved in attacks against Israelis were killed in violence across the West Bank.
Another Palestinian was killed in clashes with Israeli troops, a Palestinian hospital official said.
Bethlehem has been a focal point for clashes between Israeli troops and Palestinian protesters during the three month-long wave of violence that has gripped the region.
While the annual festivities in the city's Manger Square were set to go on, other celebrations in the city were cancelled or toned down because of the violence.
More From This Section
Thousands of people were crowding into Manger Square, admiring the town's Christmas tree and listening to holiday music played by marching bands and scout troops.
Since mid-September, Palestinian attacks have killed 20 Israelis, while Israeli fire has killed 124 Palestinians, among them 85 said by Israel to be attackers. The rest were killed in clashes with Israeli forces.
In recent years, Bethlehem had enjoyed a relative calm and thousands of revelers and pilgrims poured into Manger Square each Christmas. But vendors and hotel owners in the city have already complained of sagging business this Christmas season.
Twal will lead worshippers in a Midnight Mass at the Church of the Nativity, built atop the spot where Christians believe Jesus was born.