The Israeli and Palestinian presidents are to pay a symbolic visit to the Vatican next month to pray for peace.
Pope Francis plunged into Middle East politics during his Holy Land pilgrimage, calling the current stalemate in peace efforts "unacceptable".
Francis issued the surprise joint invitation after landing in Bethlehem. In another unscripted moment, he prayed at the Israeli separation barrier surrounding the biblical West Bank town and briefly donned the black-and-white headscarf that is a symbol of the Palestinian cause.
Jubilant Palestinians cheered Francis as he arrived in Bethlehem's Manger Square, shouting "Viva al-Baba!" or "Long live the Pope!"
Giant Palestinian flags in red, white, green and black and the Vatican's yellow-and-white flags decorated the square.
At the end of Mass in the square, Francis invited Palestinian president Mahmoud Abbas and Israeli president Shimon Peres to pray with him for peace, saying: "I offer my home in the Vatican as a place for this encounter of prayer."
The offices of the Israeli and Palestinian presidents quickly confirmed that they had accepted the invitation, with the Palestinians saying the meeting would take place in June.
The invitation - and the acceptances - were unexpected given Francis's insistence that his three-day visit was "strictly religious" pilgrimage to commemorate a Catholic-Orthodox anniversary.
Israeli-Palestinian peace talks broke down in late April, and there have been no public high-level meetings for a year.
Mr Peres, a 90-year-old Nobel Peace laureate, is set to step down over the summer, and the meeting would take place shortly before he leaves office.
Francis started out the second day of his three-day trip with a deeply symbolic decision to land in at a Bethlehem helipad, arriving from Jordan aboard a Jordanian helicopter. Previous popes have always come to the West Bank after first arriving in Tel Aviv, Israel.
Palestinian officials hailed Francis's decision to arrive first in Bethlehem, and to refer to the "state of Palestine."
In its official programme, the Vatican referred to Mr Abbas as the president of the "state of Palestine," and his Bethlehem office as the "presidential palace."
"It's a blessed day," said Samar Sakkakini, 52, a Palestinian-American from Canton, Michigan, who attended the Mass in Manger Square.
"Coming to Bethlehem and flying to Bethlehem from Jordan shows solidarity with the Palestinian people, which is wonderful. We need that."
Standing alongside Mr Abbas at a welcome ceremony, Francis declared: "The time has come to put an end to this situation which has become increasingly unacceptable."
He said both sides needed to make sacrifices to create two states, with internationally recognised borders, based on mutual security and rights for everyone.
"The time has come for everyone to find the courage to be generous and creative in the service of the common good," he said, urging both sides to refrain from any actions that would derail peace.
In his remarks, Mr Abbas voiced his concerns about the recent breakdown in US-backed peace efforts and lamented the difficult conditions facing the Palestinians. He also expressed hope for peace.
"Your visit is loaded with symbolic meaning as a defender of the poor and the marginalised," he said.
Mr Abbas listed a series of complaints against Israel, including continued settlement construction, the plight of thousands of Palestinian prisoners, Israel's control of east Jerusalem - the Palestinians' would-be capital - and Israel's construction of the "ugly wall" that encircles Bethlehem.
"We welcome any initiative from you to make peace a reality in the Holy Land," Mr Abbas said.
"I am addressing our neighbours - the Israelis. We are looking for the same thing that you are looking for, which is safety, security and stability."
Security was lax by papal standards, even for a pope who has shunned the armoured popemobile that his predecessors used on foreign trips.
Only two bodyguards stood on the back of Francis' vehicle keeping watch as Palestinian police kept the crowd at bay.
Francis waved and warmly smiled as his car made its way through the crowd in Manger Square, at one point holding a child passed up to him.
After Mass, Francis had lunch with Palestinian families and visited a Palestinian refugee camp before flying by helicopter to Tel Aviv's Ben-Gurion airport for the Israeli leg of his trip.