It was the first suicide attack in Israel in six weeks, and came after Israel turned down a Palestinian offer to halt attacks on civilians as the first stage of a gradual truce.
There was no immediate claim of responsibility.
The blast went off during afternoon rush hour near the Israeli Arab town of Umm el-Fahm.
Mohammed Akbariyeh, a witness, said he was sitting in a restaurant near the bus stop when the bomb exploded.
"Suddenly, we heard a huge explosion. The ground just flew upward. We ran to the spot. We saw a police car which had been damaged from the rear. One policeman was wounded and another man was also wounded. The body of the terrorist was simply cut in two," Akbariyeh told Israel Radio.
David Baker, an official in Israeli Prime Minister Ariel Sharon's office, said that "Palestinian terrorists have once again set out on a bloodletting of the Israeli public."
It was the first suicide attack since Aug. 4, when a bomber blew himself up on a bus, killing himself and nine Israelis.