In announcements from mosque loudspeakers, the group said that Hani Awijan, the leader of its Nablus wing, was killed by Israeli undercover troops.
Islamic Jihad said the troops came to arrest him while he was playing football with friends and relatives.
Another fighter was also killed.
The Israeli army confirmed soldiers had operated in Nablus and said a member of Islamic Jihad was killed in an exchange of fire.
Israeli radio said Awijan was responsible for a series of attacks on Israelis.
Over the past 17 months, Islamic Jihad has been responsible for all 12 suicide bombing attacks in Israel, killing 71 people.
News of the incident spread through Nablus and large crowds gathered at the hospital.
Members of Islamic Jihad burned tyres in the streets and called for a general strike in the city.
Early Saturday, some Israeli tanks moved back into Gaza a day after completing a two-day raid in the northern part of the seaside strip in which 30 Palestinians were killed.
Most of those who died were fighters, but some were civilians, including an elderly woman and a child.
Late Saturday, residents reported Israeli tanks moving in a buffer zone east of Gaza City, a frequent area of Israeli operations, to try to stop Palestinian fighters from firing rockets at Israeli communities.
On Sunday, Israeli aircraft destroyed a house belonging to a fighter in Gaza City, residents said.
Israel warned the occupants to leave and the house was empty. Three people nearby were wounded.