The attack came as US-led forces launched raids across the country to mop up insurgents. Military spokesman Brigadier General Mark Kimmitt said more than 100 suspected guerrillas had been taken into custody since yesterday.
The bombing in the bustling Karada district of central Baghdad, was the second attack on US troops in the area in three days. Two children and a US soldier were killed in a similar blast on Sunday.
"The pavement just blew up everywhere," said Mr Abbas Aboud, a passing motorist who received minor wounds to his face.
The capital has been on tenterhooks because of fears of increased attacks around New Year. The US-led coalition has stepped up patrols and warned troops and staff to be vigilant.
The Karada bomb went off as hundreds of people were out on the streets -- children going to school, workers going to their offices and shopkeepers opening up for business.
Witnesses said the bomb, most likely placed on the concrete divider of a main street, was apparently aimed at two US military vehicles passing by. Neither was badly damaged.
One Iraqi was killed on the spot.