The typically surreal event involved 50 children hosted by an actor dressed as Queen Elizabeth II for a British-style tea party.
Their party hats were bullet-riddled helmets with British flags on them, while tattered Union Jacks were flown.
The queen revealed a plaque carved in concrete saying “Er, Sorry,” playing on the common initials for Elizabeth Regina.
The apology was etched into Israel’s controversial separation wall, which in many areas cuts through Palestinian territory.
The children were descendants of Palestinians forced to flee their land in the 1948 war surrounding the creation of Israel.
Thursday marks the 100th anniversary of the Balfour Declaration, when the British government said it viewed “with favor the establishment in Palestine of a national home for the Jewish people.”
Palestinians see the document as giving away their homeland, while Israelis see it as helping pave the way to the founding of their country at a time when Jews were facing persecution elsewhere.
“This conflict has brought so much suffering to people on all sides. It didn’t feel appropriate to ‘celebrate’ the British role in it,” Banksy said in a statement.
“The British didn’t handle things well here — when you organize a wedding, it’s best to make sure the bride isn’t already married.”
Gemma Bell, a British woman among a group who walked part of the way from London to Jerusalem to apologize for their government’s role in Balfour, hailed the work.
“It’s what we should expect from Banksy — brilliant, unpredictable, dramatic and really getting that message home.”
The British government has said it will mark Thursday’s anniversary “with pride,” with Israeli Prime Minister Benjamin Netanyahu to attend a dinner in London with his British counterpart Theresa May.
Banksy opened the Walled-Off Hotel near Bethlehem in March, with all the rooms facing directly onto Israel’s separation wall.
At the time, he said it had the worst view of any hotel in the world.
Dozens of his works are found inside the hotel.
Wissam Salsaa, the hotel’s manager, told AFP they wanted to protest against the British government’s attitude to Balfour.
“This event is a protest or a commemoration of the disastrous Balfour Declaration that caused a catastrophe for the Palestinian people and a catastrophe for the Middle East,” he said.
“The British people and government, represented (here) by the queen, should apologize to the Palestinian people.”
The wall is one of the most striking symbols of Israel’s 50-year occupation, and has become a major focus for demonstrations and artwork.
Banksy closely protects his identity and was not said to be in attendance Wednesday.