Urban innovation circle is an innovation system with high concentration and high density of innovation elements. This study attempts to integrate industrial agglomeration and digital economy into the analysis framework of urban innovation and development ability. Based on the panel data of 262 prefecture-level cities in China from 2005 to 2020, the impact of industrial agglomeration on urban innovation and development ability is discussed through theoretical analysis and GMM model empirical test. This paper includes three types of heterogeneous industrial agglomeration: manufacturing agglomeration, producer services agglomeration, and synergistic agglomeration of the two, and analyzes the regulatory role of digital economy in the above impacts. The main conclusions are as follows: industrial agglomeration has a positive promoting effect on urban innovation, and the promoting effect order is that manufacturing agglomeration is greater than collaborative agglomeration, and producer services agglomeration ranks last. The heterogeneity test shows that, in terms of the impact of industrial agglomeration on urban innovation, the southern cities all have a significant promoting effect, while the northern cities only have a significant promoting effect on urban innovation. Digital economy only plays a positive moderating role in the promoting effect of manufacturing agglomeration on urban innovation, and plays a negative moderating role in the influence of producer services agglomeration and collaborative agglomeration on urban innovation.