Most fish and aquatic amphibians use the lateral line system, consisting of arrays of hair-like neuromasts, as an important sensory organ for prey/predator detection, communication, and navigation. In this paper a novel bio-inspired artificial lateral line system is proposed for underwater robots and vehicles by exploiting the inherent sensing capability of ionic polymer-metal composites (IPMCs). Analogous to its biological counterpart, the IPMC-based lateral line processes the sensor signals through a neural network. The effectiveness of the proposed lateral line is validated experimentally in the localization of a dipole source (vibrating sphere) underwater. In particular, as a proof of concept, a prototype with body length (BL) of 10 cm, comprising six millimeter- scale IPMC sensors, is constructed and tested. Experimental results have shown that the IPMC-based lateral line can localize the source from 1-2 BLs away, with a maximum localization error of 0.3 cm, when the data for training the neural network are collected from a grid of 2 cm by 2 cm lattices. The effect of the number of sensors on the localization accuracy has also been examined.