After seven lean, intifada years, Joseph Canavati, owner of the modern Alexander Hotel on Manger Street, the snaking main road leading to the Church of the Nativity, is dusting off his "No vacancies" sign. The pilgrims are coming back.

"This is the best year we've had since the uprising," he beamed. "There are peace talks. There's no violence in the Bethlehem area, no violence in Jerusalem. Our business depends on tranquillity. If there is no violence, there is business." The guests for his 44 rooms come from the United States, Italy, Lithuania, and South Korea.

All 2,000 beds in Bethlehem hotels and hostels are booked for Christmas for the first time since 2000. Victor Batarseh, the West Bank city's Roman Catholic mayor, expects 40,000 pilgrims to visit Jesus's birthplace for the holiday.

Despite the bleak welcome of Israel's concrete security wall at the entrance to the city, there is renewed buoyancy in the streets: more coloured lights and decorated trees, few if any political slogans or portraits of Chairman Arafat. The roads, once ravaged by Israeli shells and armoured vehicles, are swept and repaired.

"God bless this bus station" reads a sign in the underground coach park built for the Millennium. The Muslim feast of Id al-Adha shades this year into Christmas. Every one of Bethlehem's 32,000 residents has something to celebrate.

Israel is trying to help. "We all share the same economic interest," said Shaul Tzemach, director general of the Tourism Ministry. Procedures have been streamlined for pilgrims at checkpoints between Bethlehem and Jerusalem, 10 minutes' drive to the north.

Tourism is Bethlehem's main source of income. The figures are up throughout the year. "We had an excellent summer," Mr Canavati reported, "followed by a good October and November. The hotels in Jerusalem were so full that we got the overflow."

The Israeli Tourism Ministry logged one million Christian visitors to the Holy Land in 2007, at least half of them pilgrims. The mayor said the number of visitors to Bethlehem was back to 60-70 per cent of pre-intifada trade.

But the recovery is fragile. Unemployment is down from 60 per cent a year ago to 45 per cent now. The gift shops are open; the factories carving olive wood and mother of pearl nativity tableaux are back in production. But thousands of labourers who used to work in Jerusalem are barred from entering Israel, though Israel is allowing Palestinian Christians and Muslims to visit relatives across the de facto border for their respective holidays.

It is small comfort for hundreds of Bethlehem families whose kin have settled much further afield. The pilgrims are coming, but the Christians are leaving. Before the creation of Israel in 1948, 92 per cent of the city's population were Christian. The mayor, a retired ear, nose and throat surgeon, puts the current ratio at 35 per cent Christians to 65 per cent Muslims and says that at least 400 Christian families have emigrated from Bethlehem in the past three to four years.

Samir Qumsieh, who runs Nativity, a private Christian television station, said: "Emigration is deadly. In 15 years you will not find Christians here." Three of his four brothers live abroad. He blames the exodus on the Israeli occupation, internal problems (for which read militant Islam) and the fact that "there is no life here".