Palestinian President Mahmoud Abbas told pilgrims in Bethlehem on Christmas Eve that "the new year, God willing, will be a year of security and economic stability."
Thousands gathered in Bethlehem on Monday for a Christmas mass promoted by and Western powers as a chance to highlight the benefits of peacemaking.
"We pray next year will be the year of independence for the Palestinian people," Abbas continued.
Christmas carols played through a packed Manger Square ahead of the traditional midnight mass, though the majority of those gathered were Palestinians and not the foreign tourists local vendors were hoping for.
Earlier in the day, religious and political leaders arrived in the town where Christians believe Jesus was born.
At a U.S.-sponsored peace conference last month, Abbas and Prime Minister Ehud Olmert launched negotiations with the goal of reaching a statehood agreement by the end of 2008.
Ahead of the festivities, Palestinian security forces, many carrying newly issued rifles, took up positions on the streets of Bethlehem in numbers not seen in years.
"Despite all the security, people couldn't be more friendly," said Eaddy Kiernan, 22, on holiday from the United States, about the large number of armed guards. "It's the most special place you could celebrate Christmas."
Bethlehem was particularly affected when tourism slumped during the early years of a Palestinian uprising - or Intifada - that erupted in 2000.
Israel allowed dozens of Christians from Gaza to travel to Bethlehem to take part in the festivities
Store owners this year say they are celebrating their most peaceful - and profitable - Christmas in seven years.
"We are more satisfied. The economic situation is getting a little better," said Khaled Msalam, a 42-year-old Bethlehem shop owner. "Still, people have financial trouble and can't afford a lot of our products."
Tourism, the lifeblood of Bethlehem's economy, has improved as Western powers have sought to bolster Abbas in his power struggle with Hamas Islamists who took over the Gaza Strip in June.
Nadia Hazboun, who manages a souvenir store opposite the Church of the Nativity said: "This year is better than other years because this peace process is making people feel more calm."
After struggling for years to fill rooms, many Bethlehem hotels are fully booked for Christmas.
Middle East envoy Tony Blair has been trying to improve tourist access and facilities in Bethlehem. The former British prime minister recently stayed overnight in one of the city's best hotels to send a message it is safe.
But local leaders remain cautious; tourism numbers still hover at just 60-70 percent of pre-Intifada levels, and many Western governments still warn against non-essential travel.
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