Rescuers said people were trapped under collapsed shops and buildings.
"There was a deafening sound and I was like a blind man for a few minutes," Mohammad Usman, who was wounded in the shoulder, said.
"I heard women and children crying and started to help others. There was the smell of human flesh in the air."
Omar Waraich, a journalist with The Independent newspaper, told Al Jazeera: "The blast will create a great deal of despair, certain panic.
"This is not the first time such a marketplace has been hit. What you're seeing is a gradual escalation.
"The question many people will be asking is, 'what is the government doing to protect these people and thwart these attacks before they're even mounted?"
Imran Khan, Al Jazeera's correspondent in Islamabad, said officials had told him that a car drove into a narrow and packed market place before exploding.
"The bomb disposal squad are at the location and are looking for clues as to what type of explosive was used," he reported.
"From there they will be able to tell what organisation was behind the bomb-making, because they will be able to link it to previous attacks.
"This goes to show that the security situation in Pakistan is very delicate as the US secretary of state is in Pakistan for the first time."
Ban Ki-moon, the UN secretary general, condemned the "appalling bomb attack".
"I want to express my outrage at the loss of so many innocent lives," he told a news conference in New York.
The blast comes as Pakistan's military is fighting members of the Tehreek-e-Taliban Pakistan (TTP) in the country's semi-autonomous tribal region of South Waziristan.
The military launched its offensive nearly two weeks ago, pitting about 30,000 Pakistani troops against an estimated 10 to 12,000 Taliban fighters in South Waziristan.
Tariq Azeem Khan, a Pakistani senator and a former minister of state for information, told Al Jazeera: "The Taliban and the terrorists are getting reckless now.
"When they cannot get to the main targets because they are well guarded, they are doing these explosions all over the place - in the main shopping centres without any pre-determined targets.
"There's very little the government can do to try to protect every single shopping mall. It's a difficult task, but they are doing their best. Pakistan is paying a very high price at the moment.
"We had expected that we would get this rise in terrorism before the operation in Waziristan dies down."
Since the South Waziristan assault began, the military says it has killed at least 231 fighters, and lost 29 soldiers. However, independent tolls are impossible to come by as journalists and aid agencies are barred from the conflict zone.
More than 125,000 people have been registered as displaced by Pakistan's offensive in South Waziristan since October 13, United Nations officials have said.
The UN High Commissioner for Refugees has said that humanitarian access to people in need remains the key challenge for agencies, given the volatile security environment in the displacement areas.
The military has given no figures for civilian casualties, but those fleeing say many people caught in the middle have been killed.