The powerful blast partly demolished the three-storey Marhaba Hotel in the centre of the strife-torn city near the Afghan border, an AFP reporter at the scene said.

Body parts littered the road outside the hotel, opposite the historic Mahabat mosque, and television footage showed frantic passers-by wheeling badly mutilated bodies into local hospitals on wooden carts.

Interior Ministry spokesman Brigadier Javed Cheema told AFP that 25 people were killed, most of them Afghans.

"It is now confirmed that it was a suicide attack," said Malik Zafar Azam, the law minister for North West Frontier Province, of which Peshawar is the capital.

"Police have found two severed legs. One leg bears a marking in Pashto language saying 'This will be fate of those who are American spies,'" he said.

Attacks on people suspected of spying for US forces across the border in Afghanistan have escalated in northwestern Pakistan in recent months, especially in its lawless tribal areas near the frontier.

Azam said the blast was also thought to be linked to a suicide attack at nearby Charsadda on April 28 which killed 29 people and injured the country's interior minister.

An employee of the hotel, Abdul Rashid, told reporters that the owner, an Afghan refugee, and his three sons were killed in the blast. Officials said the hotel was popular with Afghans.

Hospital and police sources said two women and a child were among the dead. At least 46 people were wounded and many were in a critical condition, while ambulances continued to ferry more casualties.

"The blast was so powerful that some of the bodies had their heads blown off," said Jan Baz, a doctor at the city's main Lady Reading Hospital, where most of the casualties were taken.

Provincial chief minister Akram Durrani announced 100,000 rupees (1,666 dollars) compensation for the families of the victims.

Pakistan has been rocked by a series of deadly blasts this year, many of which have been linked to its ongoing offensive against Taliban and Al-Qaeda militants hiding out in its remote tribal areas bordering Afghanistan.

Peshawar has a population of hundreds of thousands of Afghan refugees who fled their country during its 25 years of war. Pakistan has alleged that some are involved in militant attacks.