Pope Benedict XVI held his hands out wide to greet a crowd of applauding Palestinian refugees in the afternoon sun. Behind him stood the most striking symbol of Israel's occupation: a paint-spattered military watchtower rising above the tall, concrete wall that presses on Bethlehem.

All around him were paintings, posters and graffiti proclaiming the Palestinian cause and their hopes from their papal visitor. From an apartment block to his left hung a poster in English and Italian: "We need bridges not walls." On a balcony beneath, a Palestinian couple sat with their children, looking down as the pope waved back to them.

Today the pope made his strongest call yet for a "sovereign Palestinian homeland". He said mass in Bethlehem's Manger Square and offered his "solidarity" to the Palestinians of Gaza, telling them he wanted to see the Israeli blockade of the coastal strip lifted.

Later, he was driven in to the UN school in the Aida refugee camp on the edge of Bethlehem, home to refugees who in 1948 were forced out or fled their homes in what is now Israel.

The pope acknowledged their "precarious and difficult conditions". Today 5,000 live on desperately crowded land, an area of about 260 metres square. Their homes are in the shadow of Israel's vast concrete and steel barrier, which stretches more than 400 miles across the West Bank. It was not there when his predecessor, John Paul II, visited nine years ago – its construction a sign of just how deeply the political climate has worsened since then.

"It is tragic to see walls still being erected," Benedict said.

Wherever he went, the pope was welcomed with cheers and praise. A few thousand gathered early for the Manger Square mass, a sea of white and yellow caps, chanting "viva papa, viva Palestina" as they waited for him to appear. But even the pope himself acknowledged the thinly disguised frustration and bitterness that so many spoke of.

Yusuf Ibrahim, 67, left his farmland in a Christian village near Jenin before dawn dressed in a smart suit to make it to Bethlehem in time. It took him five hours. Like others, he talked of the decline of the Palestinian Christian community, which he said had little to do with pressure from Muslims and a lot to do with Israel's occupation. "The situation is bad. We are besieged by the wall," he said. As a West Bank resident he can only travel to Jerusalem with a special permit from the Israeli military, which he only usually receives on Christian holidays, if at all. "The Israelis are stubborn," he said. "They will not change unless the Americans and the Europeans put real pressure on them."

Joseph Giacaman, 49, spoke of the struggling Bethlehem economy and the troubles of running his Christian souvenir shop on Manger Square. Most of his family have moved abroad. "People are closed up. It's very hard to go out," he said. "They need to try to open the roads, to give permission for people to work, to come and go. We hope sometime for a peace agreement, but it's not that easy."

It was the Latin Patriarch of Jerusalem, Archbishop Fouad Twal, who expressed their anger most pointedly when he welcomed the pope to Bethlehem with a plea for help. "Our people are suffering – suffering from injustice, from war, from occupation, from lack of trust and lack of hope for a better future," he told the pontiff.

The Christian community in Palestine was in decline, he said. "As long as we don't have peace and tranquillity I am afraid this will continue. With the continuation of political instability, separating Bethlehem from Jerusalem and the rest of the world, we cannot find peace."

Palestinians laid on shows of dancing, singing and poetry readings and delivered the pope gifts, including a scarf woven in Bethlehem which was placed on his shoulders and which carried images of the star of Bethlehem, the Church of the Nativity, the Dome of the Rock and a set of keys, the symbol of the refugees who hope one day to return to their homes. Another gave him a slice of Tiberias stone shaped in a map of historic Palestine.

There was a strong round of applause from the crowd at Aida when the pope mentioned the people of Gaza. Home to 1.5 million Palestinians, Gaza has a small but dwindling Christian community. Around 250 of them had applied to the Israeli military for permits to attend the masses on the pope's tours but barely half received them. At his mass in Bethlehem, Benedict singled out the people of Gaza, offering his "sorrow for the hardship and suffering you have had to endure" and highlighting the "immense work of rebuilding that lies ahead". He also said he was praying "that the embargo will soon be lifted".

Benedict acknowledged the need for a "just and lasting solution" to the conflict between Israel and the Palestinians but grasped, too, the reality: "Your legitimate aspirations for permanent homes, for an independent Palestinian state remain unfulfilled," he said. "Instead you find yourselves trapped … in a spiral of violence, of attack and counterattack, retaliation and continued destruction."

In one of the apartments overlooking the UN school where Benedict spoke, Ayad Abu Akar said he hoped only that the Palestinian story would be better understood. His parents fled their village of Ras Abu Ammar in 1948 and Abu Akar, now 53, was born in Aida camp and has lived there all his life. All trace of his parents' village has been destroyed, replaced instead by Israeli towns. "We hope he will transfer the agony and suffering of the people in the camps to the outside world, and reflect the true picture of how the Palestinian people are living," he said. "Look at us, we don't have one metre to plant a tree."

Much has been expected of Benedict on his week-long pilgrimage to Israel and the Palestinian territories. Palestinians hoped for strong support for an independent state, although most accepted the pope himself could bring little direct influence to bear on what has become a drawn-out diplomatic stalemate.

They hoped too that he would visit Gaza, but he will not be going. Israelis hoped for strong words of condemnation over the Holocaust, long a matter of division between Israel and the Vatican. Several prominent Israeli figures said he had not gone far enough in his speech at the Yad Vashem Holocaust memorial. Tomorrow , Benedict travels to Nazareth for the largest mass of his visit, addressing a congregation of perhaps 40,000 on Mount Precipice, most of them Arabs living in Israel.

• This article was amended on 28 May 2009. The original said that the people of Aida refugee camp live on 500 sq metres of land (the figure given on the day of the papal visit by a senior UN Relief and Works Agency official). This has been corrected.

Israeli and Palestinian gifts

Pope Benedict XVI has received some unusual gifts during his pilgrimage to the Holy Land this week. When he met Israel's president, Shimon Peres, he was given a bundle of wheat, which Peres told him was a newly engineered variety that doubled the yield and had been named after the pope. He was also given a copy of the Old Testament in Hebrew printed on a nanotechnology particle the size of a grain of sand. It requires an electron microscope to read. From the Palestinians he has received a handwritten calligraphy of the gospel of Luke in Arabic, produced by a Muslim artist in Bethlehem. It took him two months to create and was the first time the calligrapher had read a New Testament text. Yesterday, the pope also received a cream-coloured scarf hand-woven with images of a Bethlehem star, the Church of the Nativity, the Dome of the Rock and a set of keys, underlining the cause of Palestinian refugees, and a piece of stone in the shape of a map of historic Palestine.ends