The blast took place at a wholesale fruit and vegetable market in the busy morning period when grocers and sellers gather to trade.
It is the deadliest attack to hit the Pakistani capital since the Marriott Hotel bombing in 2008 and comes as the government tries to negotiate an end to the Tehreek-e-Taliban Pakistan's seven-year insurgency.
"At least 17 people were killed and 50 others injured in the blast," Pakistan Institute of Medical Sciences (PIMS) spokeswoman Ayesha Isani told AFP in Islamabad.
She said the condition of two patients was very critical.
"It was a bomb blast, heard over a big radius," local police official Tehzeeb Hussain told AFP.
He said a bomb disposal team had reached the site and was collecting information.
The blast left a 1.5-metre (five-foot) diameter crater at the site which was littered with bloody body parts, an AFP reporter at the scene said.
Ambulances were rushing in and out carrying wounded people and dead bodies.
Senior local administration official Nauman Yousuf told AFP "it was a planted bomb".
A bomb disposal official told AFP on condition of anonymity that the device hidden in a fruit box weighed five to six kilograms (11 to 13 pounds) and was packed with nuts and bolts to cause maximum carnage.
The blast came a little over a month after a gun and suicide bomb attack on a court complex in Islamabad killed 11 people including a judge.
Pakistan has been in the grip of a bloody homegrown Taliban insurgency since 2007 but there have been very few attacks in recent years in the capital.