Israel has repeatedly killed wanted Palestinians in targeted missile strikes.
The explosions rocked a gold-colored stationwagon and rescue workers tried to get the passengers out. Large plumes of smoke rose into the sky, witnesses said.
The explosions went off in the Rimal neighborhood, about 300 yards from the local U.N. headquarters.
The blast came two days after a Hamas suicide bombing that killed 20, including five Americans, earlier this week in Jerusalem — the deadliest attack since the launch of the U.S.-backed "road map" peace plan three months ago.
Palestinian leaders, acting under intense U.S. pressure, on Thursday approved what appeared to be a limited clampdown on militants, as Israeli troops hunting terror suspects raided three West Bank towns and killed a 16-year-old bystander in a shooting.
At least at first, Israel decided to respond to the bombing with smaller raids, rather than with a major military offensive, to avoid derailing the peace plan.
However, Israel also said it would resume targeted killings of wanted Palestinians if the Palestinians don't take immediate action the militant groups.
Palestinian Prime Minister Mahmoud Abbas had shied away from confrontation with Hamas, Islamic Jihad and armed renegades in his own Fatah movement, saying he feared internal fighting.
However, after the Jerusalem bombing, there was mounting pressure, with the United States demanding an immediate crackdown. "There's funding, there's support, there's munitions, there's organization, and all that needs to be taken apart," said State Department spokesman Richard Boucher.
A senior U.S. envoy, John Wolf, met Thursday with Abbas. Wolf heads the U.S. team monitoring implementation of the road map.
On Wednesday, White House spokesman Scott McClellan renewed President Bush's insistence that the Palestinian Authority quickly act to dismantle all terrorist groups.
"That's the way forward. That's how we get to two states living side by side, two states, israel and Palestine, living side-by-side in peace and security," he said.
Asked if Mr. Bush wants Israel to restrain its military response to the bombing, McClellan again said Israel has the right to defend itself.
In a first step, Abbas ordered the arrest of all those directly involved in the bombing, and then asked his Cabinet for proposals on a wider clampdown. The ideas raised in the Cabinet meeting, including arrests, a gag order on Hamas and Islamic Jihad spokesmen and the freezing of assets of militant groups, were taken to Yasser Arafat and top PLO officials for approval late Wednesday.
The meeting, which lasted until early Thursday, was at times stormy. Abbas had told his ministers earlier that he would resign if he did not get Arafat's full support for taking action against Hamas and Islamic Jihad, but it was not clear whether he did make the threat in Arafat's presence.
In the end, Abbas and Arafat agreed on a joint statement which said the Palestinian Authority would enforce the rule of law, take control of illegal weapons and end "military displays" by the militants, a reference to marches led by gunmen.
Islamic Jihad and Hamas officials said they were ordered by Palestinian police not to speak to reporters, and many leaders of the two groups had their phones turned off Thursday.
The Palestinian leadership statement did not refer to arrests, which would appear to be a cornerstone of any crackdown, but Palestinian officials said there would be detentions.
"It's a campaign that even in the worst nightmares Hamas and Islamic Jihad never imagined," said Elias Zananiri, a spokesman for Palestinian security chief Mohammed Dahlan. "There's a list of people to be arrested."
Israeli troops, meanwhile, raided the West Bank towns of Nablus, Jenin and Tulkarem in search of militants. Since the spring of 2002, when Israel reoccupied most of the West Bank, troops have been moving in and out of Palestinian towns repeatedly to arrested wanted men.
After the Jerusalem bombing, Israeli Prime Minister Ariel Sharon decided not to wait for Abbas to take action, security officials said, though the raids he approved were smaller in scale than has been customary after especially deadly bombings. Israel did not call up reserves, as it did during last year's two major offensives.
The biggest operation was carried out in the Casbah, or old city, of Nablus, a militant stronghold where troops were looking for Hamas militants and Fatah renegades responsible for two bombings that killed two Israelis earlier this month.
Troops sealed off the old city with armored vehicles and barbed wire and ordered residents out of homes to search buildings. Soldiers took over several buildings as outposts, suggesting a longer stay. They arrested 14 Palestinians in and around Nablus during the night, including a Hamas member caught with a large quantity of explosives, the army and witnesses said.
In the town of Tulkarem, Israeli undercover troops chasing two Fatah gunmen raided a local pool hall, but the fugitives managed to escaped. The soldiers opened fire during the chase, killing a 16-year-old bystander and wounding four, all under the age of 20, Palestinian security officials said. The Israeli military said there was a gunbattle.
A third raid targeted the town of Jenin and an adjacent refugee camp, a stronghold of the Al Aqsa Martyrs' Brigade, a militant group loosely linked to Fatah. No arrests were made.
In the West Bank city Hebron, troops blew up the home of the Jerusalem bus bomber, a routine punishment intended as deterrent.
Israel had largely suspended such raids after Hamas, Islamic Jihad and Fatah declared a unilateral truce June 29. However, even after the cease-fire, troops continued chasing so-called "ticking bombs" — wanted men suspected of planning new attacks.
Three senior operatives, two from Hamas and one from Islamic Jihad, were killed in post-truce army operations, prompting the militants to change the terms of their cease-fire and threatening revenge for each Palestinian killed by soldiers.
In response to the Jerusalem bombing, Israel's security Cabinet decided late Wednesday to broaden the arrest raids again and to resume the policy of targeted killings, a security official said. The scope of Israeli strikes will depend on the action taken by the Palestinian Authority.
Sharon warned that if the Palestinian Authority "does not take all the necessary steps in the war against terror, real and substantial steps, it will not be possible to advance on the diplomatic track."