The decision, which allows all Muslim worshippers to attend Friday prayers, comes as Israel faces growing international pressure to defuse a crisis which many fear heralds a new Palestinian intifada, or uprising.
The Middle East peacemaking Quartet -- US Secretary of State John Kerry, his Russian counterpart Sergei Lavrov, EU foreign policy chief Federica Mogherini and UN chief Ban Ki-moon -- were to hold talks on the escalating violence later Friday.
The increasing diplomatic efforts came as Palestinian political parties called for a "day of rage" with protests to be held after Friday prayers in Gaza and the West Bank.
Hamas, the Islamist movement which rules the Gaza Strip, called in a statement for "more protests and more clashes with soldiers in the West Bank".
Thousands of worshippers streamed into the Al-Aqsa mosque compound ahead of prayers, many of whom had not been allowed in on a Friday since mid-September when clashes broke out at the site between Palestinians and Israeli police.
"Of course it is better but there are still checkpoints and searches. There is still no respect," said Wissam Abu Madi, 20, who said he believed a wave of attacks on Israelis would continue.
"Everyone is scared that if you get searched and (they think) you make a wrong move, you will get shot. It is a terrible situation."
- Lone-wolf attacks -
The Al-Aqsa mosque compound is one of the key sources of tensions between Israelis and Palestinians, as it is both the third-holiest site for Muslims and the holiest site for Jews, who call it the Temple Mount.
A visit by former prime minister Ariel Sharon - then opposition leader -- in 2000 sparked the second intifada which lasted until 2005 and left nearly 4,700 dead.
To avoid tensions Jews are allowed to visit but not pray at the site located in east Jerusalem, which was annexed by Israel in 1967.
It is managed by an Islamic foundation under the auspices of Jordan but Israel controls access.
Clashes erupted over the Jewish religious holidays last month as an increase in visits by Jews to the compound raised fears among Muslims that Israel was planning to change the longstanding rules governing the site.
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Israel then put in place age restrictions which meant only Muslim men over the age of 40, 45, or 50, depending on the decision taken on a particular week, were allowed to enter the esplanade for Friday prayers.
The protests at Al-Aqsa triggered a wave of lone-wolf knife attacks, shootings and car-rammings against Israelis.
In the latest attack Friday a Palestinian stabbed and lightly wounded a soldier in the occupied West Bank and was shot and wounded by Israeli forces.
A military spokeswoman told AFP the soldier was a Bedouin tracker who had opened a gate to enable Palestinians to harvest their olive trees.
Since October 1, at least 49 Palestinians and one Israeli Arab have been killed, including alleged attackers. Eight Israelis have been killed in attacks.
One Israeli Jew and one Eritrean have also been killed after being mistaken for attackers.
- 'There is no work' -
The recent unrest is led by a new generation of young, frustrated Palestinians who no longer see their leaders as capable of improving their lot.
Mohammed, 29, who was attending prayers at Al-Aqsa, laid the blame on the Israelis.
"They are responsible because there is no work. If there was work, if people had money, they wouldn't do anything."
The international community has launched a flurry of diplomatic activity in a bid to calm the latest round of violence in one of the oldest conflicts on earth.
US Secretary of State John Kerry on Thursday expressed "cautious optimism" after four hours of talks in Berlin with Israel's Prime Minister Benjamin Netanyahu.
"If parties want to try -- and I believe they do want to move to a de-escalation -- I think there are sets of choices that are available," he said, expressing hope that "we can seize this moment and pull back from the precipice".
Kerry was due to meet Lavrov and Mogherini on the crisis on Friday in Vienna, joined by Ban via video link from New York.
Netanyahu has repeatedly accused Abbas of fanning the flames by suggesting Israel wants to change the status quo at the compound under which Jews are allowed to visit but not pray.
The Israeli leader has insisted he has no intention of changing the rules.