Acknowledging “growing tensions” between them, he urged a “negotiated solution… that would allow the peaceful co-existence of two states”.
US President Donald Trump recently announced that America recognized Jerusalem as the capital of Israel.
The hugely controversial move drew condemnation across the Muslim world.
Last week, UN members decisively backed a non-binding resolution that said any decisions regarding the status of the Jerusalem were “null and void” and must be cancelled.
Palestinians want East Jerusalem as their future capital, and all countries currently keep their embassies in Tel Aviv.
The Roman Catholic leader was giving his Urbi et Orbi speech, which in Latin means “To the city and world”, in Saint Peter’s Square.