Mr Justice Garland said identification evidence against Nadia Zekra, 49, was "fraught with pitfalls".
He also said that evidence given against her by a police constable on duty at the embassy was "suspect, with serious inconsistencies". The judge said that he would be instructing the jury to discharge her when they sat again today.
"It would be dangerous in the extreme to allow this case to go before a jury," he said.
Mrs Zekra had been on trial with three other Arabs, who were said by the prosecution to have integrated themselves into the upper-middle class of British society as part of their bombing strategy against Jewish targets. Mr David Calvert-Smith, prosecuting, said that "astonishingly but happily" no one was killed in the two blasts in July 1994 but that substantial damage was caused.
The bomb outside the Israeli embassy, in Kensington, west London, which caused more than pounds 5m worth of damage, was left in the boot of an Audi car.
It was alleged that the four defendants, all Palestinians, were angry with Yasser Arafat for agreeing to negotiate with the Israelis.
Mrs Zekra and her co-defendants, Jawad Botmeh, 28, Samar Alami, 30, and Mahmoud Abu-Wardeh, 24, had all been in England for a long time.
Zekra, of Brook Green, west London; Miss Samar Alami, a former student of Knightsbridge, south-west London; Botmeh, of west central London, and Abu-Wardeh, of Putney, southwest London, all pleaded not guilty to conspiracy to cause explosions between 1 January 1993 and 26 May 1995.
Speaking outside the court later, Zekra said she had always been confident she would be released. "Since the arrest I was always thinking that this has to come to an end because I'm innocent. I know nothing about what they were talking about, so I was sure that this would come to an end one day."Reuse content