BETHLEHEM CELEBRATION STRAINED BY NEGOTIATIONS.

Byline: Gwen Ackerman Associated Press 

Palestinian children set off firecrackers and vendors sold nuts and corn on the cob Tuesday as pilgrims and Palestinians thronged Bethlehem's Manger Square for Christmas Eve celebrations tempered by tensions with Israel.

Palestinian leader Yasser Arafat, a Muslim, was greeted by a boy dressed as Santa Claus when he arrived from peace talks with Israeli Prime Minister Benjamin Netanyahu. The two leaders appeared to be near an agreement on Israel's long-delayed pullout from nearby Hebron and planned to meet again today.

``We don't have an agreement yet, but it's very clear that this was a meeting that was extremely productive,'' said Dennis Ross, the American Middle East coordinator, whose arrival Saturday opened the latest round of meetings. ``They have made real progress. They have in fact made the kind of progress that takes us closer to agreement.''

Latin Patriarch Michel Sabbah, who heads the Roman Catholic Church in the Holy Land, drove to Manger Square in a motorcade along roads brimming with Christmas lights and colorful decorations. Manger Square is the biblical birthplace of Jesus.

This year marks the second Christmas in Bethlehem under Palestinian rule. But unlike last year's Christmas Eve, which turned into a joyous national celebration, Tuesday's somewhat subdued atmosphere reflected recent delays and setbacks in Arab-Israeli peace negotiations.

``Last year there was a lot of hope because the redeployment (from Bethlehem) was so close to Christmas,'' said Stephanie Tashkoff, a 29-year-old from Colac, Australia, who has spent almost two years in the area.

``This year people are trying to be hopeful, but it's hard with the closure,'' she added, referring to Israel's border restrictions that have prevented most Palestinians from entering the Jewish state and made it difficult to enter autonomous Palestinian areas.

Still, there was consensus that this year represented a marked improvement over the 28 Christmases the city spent under Israeli occupation.

``A few years ago it was difficult with the Israeli army, there were checkpoints every step of the way. . . . It was hard to get up to the church,'' said Susan Nahhas from Mansfield, Ohio. Nahhas is married to a Palestinian emigre and is celebrating her third Christmas in Bethlehem.

Buildings in Manger Square were adorned with Palestinian flags. A white banner hung across the entrance to the square said: ``The King of Peace is Born.''