Police said it was the first such attack in the city in seven months.
The blast tore through the French Hill district in East Jerusalem, which was captured by Israel in the 1967 Middle East war and annexed in a move not recognised internationally.
Witnesses said the woman blew herself up as she approached a security position near the hitchhiking post, which is mostly used by soldiers.
Ambulances rushed to the scene and police quickly cordoned off the area, which was littered with broken glass and debris.
The Palestinian resistance group al-Aqsa Martyrs Brigades claimed responsibility for the attack.
The group, part of Palestinian President Yasir Arafat's Fatah faction, said its attack was in retaliation for Israeli killings of Palestinian activists in the West Bank cities of Nablus and Jenin.
The attack came three weeks after two Palestinian bombers killed 16 people on buses in the southern Israeli city of Beersheba.
Resistance group Hamas said it carried out the Beersheba bombing to avenge Israel's killing of two of its leaders in Gaza earlier this year.