This year is the first since 1994 that Bethlehem is under Israeli occupation during the holiday. And although troops withdrew to the outskirts to let celebrations go on unimpeded, locals said they could not recall a sadder Christmas.
After more than two years of Israeli-Palestinian violence, "there is no joy in people's hearts," said Raed Zarrouk, 26.
Israeli soldiers swept into Bethlehem last month after a Palestinian suicide bomber from the town blew himself up in a bus in nearby Jerusalem, killing 11 people. Israel says their continued presence is needed to prevent more attacks.
Protesting the takeover, town leaders canceled all Christmas festivities except religious observances. The highlight is Midnight Mass at St. Catherine's Church next to the Church of the Nativity, the fortress-like 4th-century church built over the grottos where tradition holds Jesus was born.
As in years past, Latin Patriarch Michel Sabbah was on hand to deliver the sermon at Midnight Mass. Sabbah, the highest-ranking Roman Catholic clergyman in the Holy Land, led a procession from Jerusalem. He was greeted by Palestinian Boy Scouts carrying — instead of the traditional drums and bagpipes — Palestinian flags and pictures of Yasser Arafat.
Israeli troops kept a tight grip on roadblocks and checkpoints on the outskirts of Bethlehem. But no armored vehicles were visible in Manger Square, where Palestinian police in plain clothes directed traffic and erected barriers to guide worshippers to Midnight Mass.
The Israeli army indicated that the pullback was temporary.
Christmas in Bethlehem, which once attracted tens of thousands of pilgrims and Palestinians, has been subdued for the past two years because of Palestinian-Israeli violence. But this year marked a new low.
The tall fir tree in Manger Square, usually draped with strings of colorful lights and ornaments, stood bare. The platform built each year for choirs to serenade the holiday-makers in Manger Square was absent.
Only a few tourists braved the tension to visit the town. With the violence crippling Bethlehem's tourism-based economy, many souvenir shops shut down.
"It's very frustrating, it's very sad, and I can't do anything, and that makes it even worse," said Lianne, a Canadian English teacher.
Palestinians here feel the same, reports CBS News Correspondent Kimberley Dozier.
"We are truly incapable of feeling Christmas this year," says Vera Bahbun. Her husband has lost his job; she teaches to support the family.
Many Palestinians like them are leaving. They say they will not.
"I believe we should not surrender," says Babhun. "Hope is very important in our lives as a Christian."
This year, it's in short supply. For the Christian community here, this holiday is just a brief break from the violence and a painful reminder of a promised peace, that has failed both sides.
Several dozen protesters - most of them foreigners — marched around the square with signs denouncing Israel's occupation of the West Bank and Gaza. "No peace with settlements," read one, referring to the 150-odd Jewish communities in the West Bank and Gaza.
Arafat, barred by Israel from Bethlehem for the second Christmas in a row, complained on Lebanese TV about the lack of international action to force Israel from the town.
"Isn't it my right to ask why the world did not move when Israeli guns were turned toward the statue of the Virgin Mary?" he demanded.
The latest version of a U.S.-backed Mideast peace plan links Palestinian statehood to the Palestinians "acting decisively against terror," and calls on Palestinians to "immediately undertake an unconditional cessation of violence," according to a draft obtained by The Associated Press on Tuesday. Israel welcomed the changes to the plan, which is expected to be proposed in early 2003.
But with mistrust and bitterness growing on each side, prospects seem remote for ending the violence and resuming peace talks.
On Tuesday, Israeli soldiers on the Gaza Strip fired a tank shell at a group of Palestinians between the Karni and Erez crossings with Israel, killing a 15-year-old Palestinian and wounding three others, Palestinian hospital officials said. The military said soldiers identified suspicious figures digging near an unmanned army post and opened fire at them, assuming they were planting explosives.
Bethlehem Mayor Hanna Nasser said the best hope for ending the suffering on both sides was establishment of a Palestinian state.
"Our message to the world is to restore peace to the town of Bethlehem and all the Palestinian territories and to give the Palestinians a chance to live as real humans," he said. "We hope next year we'll have a better Christmas, and a real one."