The bombing came as visiting British Foreign Secretary Jack Straw appealed for Iraqi unity.
According to police the powerful explosion devastated the predominantly Shiite Abu Dshir general market in the capital's southern district of Dura as people went about their nightly shopping.
Call for unity
Dura, a mixed Shiite-Sunni community, has been convulsed by sectarian unrest in the last year and the attack came as Mr Straw pressed Iraq to form a government that would "bind" the violence-wracked country together.
Mr Straw's comments followed a similar call by the US ambassador and came as Iraq's ethnic and religious factions debate whether to form a government of national unity following December general elections won by the Shiites.
But Shiite leader and incumbent Prime Minister, Ibrahim Jaafari, insists that the setting up of a cabinet should be an "internal Iraqi affair".
Two months after national elections, Prime Minister Jaafari and his vote-winning Shiite United Iraqi Alliance have raised alarm that they will bypass Iraq’s Sunni minority in assembling the next government.
The Sunnis, who benefited under deposed dictator Saddam Hussein's regime, have driven Iraq's insurgency, based on their aversion to the country's Shiite power brokers and US forces.
Mr Straw, held separate meetings with Prime Minister Jaafari, President Jalal Talabani and Vice President Adel Abdel Mahdi before flying home.
"We want to see a national united government because that is what politicians say their people want," Mr Straw, on his third trip to Iraq in less than three months, told reporters at a press conference with Prime Minister Jaafari.
"But the outcome of who sits in what seat is on the Iraqi people to decide through their representatives that they have elected,” he said.
"This gives further impetus to what Iraqis say, that they want a national government that binds together different segments of the Iraqi society."
US Ambassador, Zalmay Khalilzad, has also warned that "the ministers of interior, defence, national intelligence, the national security adviser have to be people who are non-sectarian, broadly acceptable, non-militia related that will work for all Iraqis."
Iraq's Sunni Arabs have repeatedly accused militias loyal to the Shiite community of abuse and extra-judicial killings, and have alleged that "death squads" have infiltrated some interior ministry forces.
However Prime Minister Jaafari appeared to brush off Ambassador Khalilzad's warnings.
"I do not know exactly if the (US) ambassador had said that directly or this statement was attributed to him, but I think that selection of the ministries and making a political plan is an internal Iraqi affair and will be decided by Iraqi politicians," said Prime Minister Jaafari.
Support for Troops
During his visit, Mr Straw strongly defended his troops, currently engulfed in an abuse scandal in Iraq over video footage showing British soldiers beating four Iraqi youth during a riot in the southern town of Amara. Mr Straw vowed to bring the perpetrators to justice.
"There is a thorough investigation underway and the military has a good record of being very tough in such investigations," he said.
Four young Iraqi Shiites who said they were beaten by the soldiers are seeking damages after bringing a civil complaint before a local court, their lawyer said.
Hostage release
Meanwhile, Jordan's Prime Minister Maaruf Bakhit announced that a Jordanian embassy driver held hostage in Iraq since December has been released, the state-run Petra news agency reported.
The driver was snatched in southern Baghdad on December 20 by a group calling itself the Hawks Brigade who threatened four times to kill him.