The British urban artist often grapples with political issues and as such the scene is set against the backdrop of the Israeli separation barrier which has been pierced by a blast and left the shape of a star.
The work titled "The Scar of Bethlehem" is a play on the words star and scar, the hotel's director Wissam Salsaa told Efe news.
"Banksy tries again (with this manger) to raise the question of the wall that surrounds the city and due to which the population will celebrate another Christmas without freedom," Salsaa added.
Banksy shared the artwork on Instagram, described it as "a modified nativity set for the @walledoffhotel".
The Walled off Hotel is a collaborative project between Salsaa and Banksy.
Dubbed an "art hotel" the premises are located 500 meters from the Jerusalem checkpoint and faces the eight-meter high Israeli wall which stretches for 700 km and was erected in 2003.
The hotel as well as hosting guests has a museum and art gallery, financed by the artist, open to visitors.
The artworks are political in nature and many are anonymous.
The highest representative of the Catholic Church in the region Pierbattista Pizzaballa will cross one of the gates of the imposing barrier in order to make the traditional pilgrimage from Jerusalem to the Basilica of the Nativity, which protects the cave where, according to Christian tradition, Jesus was born.
Adjacent to the looming gray concrete, Banksy created the hotel in 2017.
( With inputs from IANS )