A Palestinian man was shot dead after going on a bulldozer rampage in Jerusalem on Tuesday, wounding at least 16 people as he ploughed into cars in the second such attack this month.

Jerusalem police chief Aharon Franco said the assailant, identified as a man from occupied east Jerusalem, rammed his vehicle into a bus near the King David Hotel, failing to overturn it, but smashing its windows.

"The bulldozer then rammed five cars and damaged them. A civilian tried to stop him when a border guard arrived and neutralised him."

The attack comes on the eve of a visit by US presidential candidate Barack Obama who is to meet Israeli and Palestinian officials on Wednesday on the latest leg of a tour of the Middle East and Europe.

"I was going home when I saw the tractor going into a bus four or five times. All the windows of the bus exploded," said Yohanan Levine, 16.

"Then I saw the tractor going down the street pushing cars. At this moment I looked (the driver) in the eye and I saw more people running, and after two minutes I heard two or three gunshots."

The White House urged "all parties" in the Middle East to condemn the attack if Israel determines it was an act of terrorism.

"Terrorist attacks do nothing to further the goals of Israel and Palestine living side by side in peace, a goal the president has been advocating for, and that both of those countries' leaders have been working toward," said spokeswoman Dana Perino.

Obama condemned the attack, telling reporters in neighbouring Jordan he would support Israel "in confronting terrorism and pursuing lasting peace and security."

"Today's bulldozer attack is a reminder of what Israelis have had to courageously live with on a daily basis for far too long."

On July 2, a Palestinian killed three people and wounded 30 others when he rammed a bulldozer into buses and cars on a busy Jerusalem street before being shot dead.

The King David regularly hosts the rich and famous. British Prime Minister Gordon Brown stayed there on his visit to Jerusalem earlier this week and Obama will be staying there during his trip.

"We heightened security immediately after the attack and we will heighten... until after Obama's visit," police spokesman Micky Rosenfeld said.

The attacker was named as Ghassan Abu Tir, 22, from Umm Tuba, a district of east Jerusalem, which Israel captured in the 1967 war and annexed in a move not recognised by the international community.

In the July 2 incident, the perpetrator was a 30-year-old east Jerusalem man who worked for an Israeli company at a nearby construction site.

In that case, all indications were that what Israel called a terrorist attack was a spontaneous incident carried out by a father of two with a criminal past but no known links to armed groups.

"I condemn terrorist attacks with the greatest firmness, and I hope for the quick recovery of those who were hurt," Palestinian president Mahmud Abbas said after meeting his Israeli counterpart Shimon Peres.

Kenny Leiner, 67, a New Yorker living in Jerusalem, said he was eating at a restaurant when "we heard a boom and the waiter alerted us that it was a terrorist attack.

"I started to run after the truck. I thought maybe I could do something. I saw the driver going boom in a car, boom in a second car. Then the police started to shoot at him. I feel horrible."

Prime Minister Ehud Olmert's spokesman Mark Regev said: "This was another attempt to murder innocent people in a senseless act of terror."

Jerusalem Mayor Uri Lupolianski said Israel should "reconsider the way in which we employ Arabs on construction sites."

Public Security Minister Avi Dichter told public radio "it is clear that the demolition of terrorists' houses and the expulsion of terrorists ... is the most effective sanction I know."

At least 525 people have been killed since peace talks between Israel and the Palestinians resumed in November after a seven-year hiatus, mostly militants in the besieged Gaza Strip, according to an AFP count.