Right-wing Israeli ultranationalists marched through occupied East Jerusalem on Tuesday evening, shouting: "May your villages burn."
About 2,000 police officers had been deployed and medics said 17 Palestinians were injured as officers cleared streets ahead of the planned flag march.
Police used rubber bullets and foul-smelling 'skunk' water against Palestinians gathering to protest against the parade.
Hamas in Gaza responded by launching incendiary balloons that started at least 10 fires in southern Israel.
The march, coming less than a month after an 11-day war in Gaza that killed more than 280 Palestinians and 12 people in Israel, was expected to further stoke tensions between Israelis and Palestinians.
But the feared escalation did not come to fruition in the early evening. The around 2,000 Israeli attendees fell short of the expected 5,000, and the march ended two and half hours after its start.
Israeli police prevented Palestinians from entering the area after forcing protesters from it earlier on Tuesday.
A small group of local shop owners and their families attempted a silent sit-in at Damascus Gate, but were told to leave by Israeli police.
One of the few remaining Palestinians, Abu Baker Shimi, 63, shouted in reference to the revered mosque: "Al Aqsa is for every Muslim."
Hundreds of nationalists gathered several hundred metres from Damascus Gate before the early evening march. Most appeared to be young, religious men, and many held Israeli flags.
“We are going to march,” said Matan Peleg, 40, a march organiser working with Im Tirtzu, Israel’s largest Zionist organisation.
"The first march was stopped on Jerusalem Day and now we won't go back," he told The National.
"Israel is a Jewish state and we are not going to surrender to terrorists and fanatics. If Israel changes its character, it will not survive – it will be just another country where women are raped and people are persecuted."
Police have closed streets in areas mainly populated by Palestinians along the route to the Damascus Gate and those skirting the Old City's ramparts.
Palestinian activists organised groups in Ramallah, Jerusalem and other places to come together to protest against the flag march. An hour before the event, police began pushing Palestinians away from the gates.
“We are here to prove to this government that it is possible to share Jerusalem if they would like to have real peace, a peace without occupation," said Aisha, a 75-year-old Jerusalem-born Palestinian. She declined to share her last name for fear of being arrested.
"They speak of a democracy, but where is the democracy when you have 2,000 soldiers here?”
The flag march was originally set to take place on May 10 as part of the commemoration of Jerusalem Day and police had diverted the route around Damascus Gate and the Muslim Quarter in the Old City due to the already tense situation in the area.
The march was eventually cancelled minutes after it started along the new route after Hamas began firing rockets into Jerusalem and sirens were heard all over the city.
On Tuesday afternoon, Hamas-linked Palestinians launched a number of incendiary balloons from Gaza, starting at least 10 blazes in southern Israel, according to Israel’s national fire department.