Although himself a Muslim, Mr Arafat enjoys ecumenical support among Palestinians, and his wife Suha comes from a prominent Christian family.
Religious celebrations went ahead as planned, with Christians attending Midnight Mass in the church which marks the place where Jesus is believed to have been born.
The annual Christmas procession by the Patriarch of Jerusalem, Michel Sabbah, on Sunday afternoon was conducted without music.
But the traditional open-air concerts and firework displays were cancelled, and Christmas lights kept to a minimum.
Millions of dollars were spent on smartening the town up for Christmas 2000 - but only a handful of pilgrims have braved the bloody confrontations in the Holy Land to visit the Palestinian-ruled town.
"It is a sad Christmas this year because of the absence of peace in the city of peace and joy," said Bethlehem's Mayor Hanna Nasser.
"It's Christmas because we know it's Christmas, not because we can feel it," she said. "They are mourning their dead and wounded."
Bethlehem and its surrounding villages have been the scene of particularly fierce battles between Israeli forces and Palestinian militias.
Previous Christmas celebrations have included exuberant displays of Palestinian nationalism as well as Palestinian Christianity.
Arafat visit
In what commentators described as a morale-boosting visit, Palestinian leader Yasser Arafat arrived in the town to attend Midnight Mass in the Church of the Nativity - as he has done every year since Israel ended its occupation of Bethlehem just before Christmas 1995.
Although himself a Muslim, Mr Arafat enjoys ecumenical support among Palestinians, and his wife Suha comes from a prominent Christian family.
It is the first time Mr Arafat has set foot in the West Bank since shortly after the upsurge of violence began at the end of September.
Israel has imposed a blockade on Bethlehem and other Palestinian towns since the uprising began, crippling the economy and preventing most tourists and pilgrims from visiting the town.
Tourism, the lifeblood of Bethlehem, has been a casualty of the unrest.
The Israeli army said the roadblocks would be open for the holiday "only as far as the security situation allows".
This year the Christian festive season is unusual in nearly coinciding with the date, by the Muslim lunar calendar, for breaking the fast at the end of Ramadan which comes on Tuesday or Wednesday.
But as Hanna Nasser says, few people on the Arab side in the Holy Land are in a mood for celebration: "People are mourning the Palestinians killed in the Intifada (uprising), the many houses destroyed and because the city is tightly closed."