In a homily, Latin Patriarch Fouad Twal called on Jews, Muslims and Christians to "live together as equals".
Referring to violence in Gaza and Jerusalem, he said he hoped 2015 "would be better than this difficult year".
Thousands of pilgrims earlier crowded into Manger Square to watch a procession led by Patriarch Twal.
The midnight Mass took place in the Church of the Nativity which marks the spot where Christians believe Jesus was born in the West Bank town.
Patriarch Twal, the most senior Roman Catholic cleric in the Holy Land, said the region had become "a land of conflict".
"I hope next year there will be no separation wall and I hope we will have bridges of peace instead," he added. "Peace comes from justice and we have a cause which we hope will be solved soon."
He appeared to be referring to the barrier Israel is building in and around the West Bank, which separates Bethlehem from Jerusalem, and the Palestinians' submission to the UN Security Council of a draft resolution that would set a 12-month deadline to reach a peace deal with Israel.
"Our message this Christmas is a message of peace like every year, but what we added this year is that all we want from Christmas is justice," said Palestinian Tourism Minister Rula Maayah.
"Justice for our people, justice for our case and the right to live like all other people in the world in our independent state without the occupation."
Patriarch Twal urged Christians not to forget the residents of Gaza, where up to 19,600 families displaced by the 50-day conflict between Israel and Palestinian militants are still in need of medium- and long-term shelter, and the people of Syria and Iraq, who are struggling to cope with a civil war and the advance of jihadist militants from Islamic State (IS).
At the scene: Quentin Sommerville, BBC News, Bethlehem These are Bethlehem's biggest two days of the year - the one occasion when, for Christians, it displaces Jerusalem. The Holy Land is the cradle of Christianity, a point Pope Francis made when he visited earlier this year.
The Pope's Christmas message to Christians - do not be afraid or ashamed of your faith - comes at a time when Christianity is under threat in the Middle East like never before.
Islamic State has pushed some of the world's oldest Christian communities out of their homes in northern Iraq. For some, the choice was convert to Islam, or die. So instead, tens of thousands fled to Kurdistan. There they remain, sheltering in churches and schools with few possessions.
Here in Manger Square there is song, and celebration, but as the Pope himself said, there will be tears and sighs alongside the hymns, as the faithful look towards 2015 with fear for the future of communities that have existed here for 2,000 years.
On Tuesday, Pope Francis - who prayed at the West Bank barrier and called for an end to the "increasingly unacceptable" Palestinian-Israeli conflict when he visited the region in May - sent a message of solidarity to Christians in the Middle East.
In a letter, the Pope wrote that for them, "the music of your Christmas hymns will also be accompanied by tears and sighs".
Without mentioning IS by name, he spoke about "the work of a newer and disturbing terrorist organisation, of previously unimaginable dimensions, which has perpetrated all kinds of abuses and inhuman acts".
But the Pope said the presence of Christians in the Middle East was precious and he urged them to work with their neighbours to reiterate that Islam is a religion of peace.
In Baghdad, Chaldean Patriarch Louis Sako said about 150,000 Christians had been displaced since IS launched an offensive in northern Iraq in June and told members of religious minorities that they would have to convert to Islam, pay a special tax or leave.