Mourinho, the 50-year-old self-styled 'Special One', is arguably the most successful ever Portuguese coach.
He has won league titles in four different countries with Porto, Chelsea, Inter Milan and Real Madrid, and has led teams to two Champions League trophies.
The Setubal town hall said in a statement it had made the decision because of Mourinho's "extraordinary role in international sport".
"He is, in all fairness, one of the coaches in the world with the most prestige and qualification."
The exact street or avenue has not yet been chosen but the town hall's general assembly voted unanimously to approve the naming.
Setubal, located just south-east of Lisbon across the Tagus, is a former industrial hub that has become one of Portugal's most impoverished and unemployment-stricken cities.
- Sports & Recreation