The crowd roared as the Holy Fire was lit, in an ancient annual rite dating to the 4th century AD to symbolise the resurrection of Christ on Easter Sunday, an AFP correspondent said.
The church filled with smoke from the flames, and scuffles also broke out between priests and pilgrims jostling to get a better view.
Worshippers from various Christian denominations then processed through the church as pilgrims filed outside to a clamour of church bells.
Earlier, police enforced tight security and crowd control measures to keep worshippers from surging into the church.
An Israeli police spokeswoman said tens of thousands of Christians attended the ceremony, packing the church and its surroundings.
Pilgrims had to elbow their way through Damascus Gate, as all other entrances to the Old City were closed for security reasons for several hours, trapping some worshippers outside the walls.
UN Middle East peace envoy Robert Serry issued a statement denouncing what he called an "incident" before the ceremony.
He said he and other diplomats visited the Easter procession to the church at the invitation of Jerusalem's Palestinian Christian community.
But the procession was stopped at a security checkpoint before the church "despite earlier assurances... of unhindered access", Serry said.
"The Israeli police refused to allow such entry claiming they had orders to that effect.
"A precarious standoff ensued, ending in an angry crowd pushing their way through."
But an Israeli foreign ministry spokesman defended the police, calling Serry's statement "an odd communique on a non-event" and "a display of poor judgement".
The ceremony had ended peacefully thanks to "the dedicated work of the Jerusalem Police, which has handled the event with the required professionalism and sensitivity, regulating crowd movements and ensuring the safety of all attendants," said spokesman Yigal Palmor.
"Mr. Serry's statement is, at the very least, a display of poor judgement," he added.
After the ceremony, the Holy Fire was passed between worshippers in a procession to nearby Bethlehem's Church of the Nativity where Jesus is believed to have been born.
The flame will also be flown out to Greece and other Orthodox countries.
The Church of the Sepulchre, one of Christianity's holiest sites, is shared by six denominations -- the Greek Orthodox, Roman Catholic, Armenian Orthodox, Egyptian Copts, Syrian Orthodox and Ethiopian Orthodox.
The Holy Fire ceremony, a high point in the Eastern Christian calendar, was attended by pilgrims from around the world.