Local police officials declined to speculate who may have been behind the attack.
"The car was parked outside the police station. It was packed with explosives and blew up, damaging the station and several nearby shops in the bazaar," Tahir Khan, a senior police officer, told the Reuters news agency.
Al Jazeera's Kamal Hyder in Islamabad said that the blast happened at 6am (0100 GMT) in a normally crowded area of Mardan.
"Had that explosion taken place an hour later it would have sheer devastation, police officials are saying that the device was more than 60 kilograms," he said.Deafening blast
Sikander Khan, a witness, told the AFP news agency: "There were some people inside the hotel and the shops were opening then there was a deafening blast. Debris flew in the air and there was thick black smoke.
"People are saying that a man in a Suzuki car came to the hotel, parked his car outside and then entered to order a cup of tea and then disappeared."
Baitullah Mehsud, the commander of the Pakistani Taliban, announced a unilateral ceasefire on Thursday after the government initiated peace talks with tribal leaders in the South Waziristan region.
Mehsud was accused by the previous government of masterminding the assassination of Benazir Bhutto, the former prime minister, but he denies playing any part in the attack in Rawalpindi.
Kamal Hyder said that Mehsud is a powerful figure and the Pakistani Taliban would normally listen to his commands.
"However, there are splinter groups, these splinter groups could be used or exploited by certain groups within the country or outside the country," he said.
"Lately the Pakistani government has been saying their has been increased activity from across the Afghan border." Negotiations
Pakistani authorities have also recently released Sufi Mohammed, a senior pro-Taliban leader in the NWFP accused of sending thousands of fighters across the border to battle US-led forces in Afghanistan.
He promised to give up violence and carry out his campaign for the imposition of Islamic law through peaceful means.
Mohammed Sadiq, Pakistan foreign ministry spokesman, said that it was necessary to negotiate with armed groups to curb a wave attacks that have killed at least 1,000 people since mid-2007.
"We believe that military action alone will not be effective in permanently ending the phenomenon of terrorism," he said.
Mardan is the home town of Amir Haider Hoti, the new chief minister of NWFP, a secularist politician who is playing a key role in negotiations with the armed groups.