By promoting technological innovation, optimizing industrial layout and enhancing data-driven decision-making capabilities, the digital economy has significantly enhanced the innovation capabilities of cities themselves, making cities the core engine of innovation-driven development. Based on the panel data of 275 cities at the prefecture level and above in China from 2012 to 2023, the econometric model is used to empirically test the impact of digital economy on urban innovation capability. It is found that the development of digital economy can effectively improve the innovation ability of cities. The results of heterogeneity analysis show that digital economy has the characteristics of urban location heterogeneity, urban size heterogeneity, financial research input heterogeneity and policy heterogeneity. Digital economy plays a more significant role in the improvement of urban innovation capability in cities in the eastern and central regions, large and medium scale cities, and cities with high financial research investment, and the effect is affected by digital economy policies, with time lag and stages. The test results of the mechanism of action show that in the process of the impact of digital economy on urban innovation ability, there is an internal transmission mechanism of“digital economy→domestic and international double cycle→urban innovation ability”, that is, the domestic and international double cycle plays an intermediary effect between digital economy and urban innovation ability. In view of this, it is proposed to stimulate the vitality of data elements and give full play to the enabling effect of digital economy. Tap the domestic and international market demand, promote the domestic and international double cycle development. Formulate differentiated digital economy development strategies, give full play to regional characteristics and advantages, and other policy suggestions, in order to enhance the city’s innovation capacity and promote the development of Chinese-style modernization.