One US soldier was killed and three were among the 70-plus wounded in the attack, the second major suicide bombing in the capital this week. The fireball from the blast set a house ablaze, the US military said.
The attack stunned the impoverished east Baghdad district of mostly Shiite Muslims and Christians. One elderly woman was seen beating her chest in grief outside her house.
"There were some American troops blocking the highway when a US Humvee came near a gathering of children and US soldiers began to hand them candies," said Karim Shukir, 42. "Then, suddenly, a speeding car bomb showed up and hit both the Humvee and the children."
The vehicle used in the attack had a licence plate from the southern city of Basra, police said. Hospitals and police said between 11 and 13 children were killed, but the authorities were struggling to compile a count of the dead and injured.
At Kindi hospital, relatives angrily blamed those fighting against the coalition forces. One distraught woman sat cross-legged outside the operating room. "May God curse the mujahideen and their leader," she cried as she pounded her head in grief.
Hours after the attack, about 200 people turned out for the funeral of five victims, in keeping with Muslim tradition that the dead must be buried quickly. The crowd shouted "Allahu Akbar" (God is great) and some fired weapons into the air.
At the scene of the attack, the charred remains of an engine block wrapped in barbed wire lay in the blood-spattered street. A child's bicycle lay crumpled nearby.
Last September, 35 children were killed when a string of bombs exploded as US soldiers were handing out sweets at a government-sponsored celebration to inaugurate a sewage plant in west Baghdad. It was the largest death toll of children in any insurgent attack since the start of the Iraq conflict.
Many of the families of those killed in that attack blamed the Americans for the tragedy, claiming that their presence had attracted militants to the ceremony.
In a separate attack yesterday, a roadside bomb exploded near a US patrol in eastern Baghdad, killing a seven-year-old child and seriously injuring a woman.
Gunmen killed an Iraqi soldier while he was driving his car in western Baghdad, while two other Iraqi soldiers were killed in a gunfight in a separate west Baghdad neighbourhood. There was better news, however, when coalition forces in Baghdad reported they had captured Abu Abd al-Aziz, the top Baghdad lieutenant of the local al-Qaeda leader, Abu Musab al-Zarqawi.
Meanwhile, a senior official in Iraq's interior ministry acknowledged that up to ten Sunni Arabs had suffocated inside a police vehicle while in custody and said those responsible would stand trial.
He said the men appeared "to have died after the vehicle's engine was turned off, stopping the air conditioning".
The men had been held for several hours in temperatures of about 45C after an attack against an interior ministry patrol in Baghdad on Sunday.