The blast in the busy Kuningan district in South Jakarta on Thursday morning damaged the security fence around the embassy and destroyed cars parked inside the compound.
Local journalists said they had seen at least three dead bodies at the scene. They also reported that embassy staff and residents suffered injuries from flying shards of glass when the explosion shattered dozens of office windows.
The blast was heard from as far as two kilometres. A resident in Tebet, about two kilometres away, said she felt the ground shook.
The Jakarta Police Chief Inspector General Firman Gani has already begun an investigation.
Australia's foreign affairs department has warned its citizens against non-essential travel to the fourth most populous nation in the world.
PM John Howard told journalists that although it was unclear who was responsible for the blast, it appears to have been caused by a car bomb.
Indonesia has been hit by sporadic bomb attacks in recent years, including blasts in Bali in October 2002 that killed 202 people and at a luxury Jakarta hotel in August 2003 that killed 12 - all of which police linked to the outlawed Islamist group, the Jemaah Islamiya.