The bomb went off shortly after 10am (0600 GMT) on Wednesday close to a police station in the town of Baquba, 65km north of Baghdad.
"The hospital officials have told me that 68 were dead and 56 injured in the blast," said Iraqi interim Health Minister Ala al-Din al-Alwan.
Many among those killed were passengers in a minibus which happened to be nearby, our correspondent said.
There were also victims among policemen and new police recruits who had queued up nearby.
The police station in the centre of the city had come under a previous car bomb attack three months ago.
The station building itself, protected by thick blast walls, was not damaged.
Major General Walid Khalid Abd al-Salam , commander of police of Diyala province, told Aljazeera an investigation was underway into the blast. "We suspect the Ansar al-Islam and al-Zarqawi's al-Tawhid and al-Jihad group," he said.
Abd al-Salam said the police had taken precautions against such an attack. But since the number of people seeking recruitment was high, they spilled out into the pavements. This increased the toll, he said.
Victims included civilians,
policemen and new recruits
People crowded at the city's hospital to identify relatives. Many were hysterical and asked, "Where is security? Where is the new Iraqi government?"
"The Iraqi police are on the scene and handling the situation, while US forces are providing support," a US military spokesman said.
Baquba, a mixed Sunni and Shia town, has experienced frequent car-bombings and attacks over the past year.
Many of the attacks have targeted Iraqi police and National Guard officers regarded by the resistance as collaborators of the occupation force.
Meanwhile, Iraq has said a major national conference billed as a crucial next step on its road to democracy would begin on Saturday despite violence racking the country.
Organiser Fuad Masum said the conference due to be attended by about 1000 people would take place in Baghdad, even though the United Nations had requested a delay.
"Credibility is essential because any delay would be explained in a negative way," Masum said.
"Credibility is essential because any delay would be explained in a negative way"
national conference organiser
"So it has been decided that the conference will be held on 31 July for one day, or at the maximum for two days."
The United Nations, which first proposed the conference in May and said it should be held before the end of July, had pushed in the past week for it to be postponed for several weeks to allow more time to prepare for such a large gathering.
The conference is supposed to bring together representatives from all walks of Iraqi life - religious, ethnic, political and otherwise - to select a 100-member National Council to act as a check on Iraq's interim government until elections in January.