The bomb rocked Maiduguri's busiest roundabout near the popular Monday Market during morning rush hour and its force scattered body parts on the rooftops of surrounding shops, according to witnesses.
Elderly women who line the road selling peanuts and kola nuts to commuters were among the victims, as were children who beg at the roundabout each day.
The defence ministry said in a tweet that an "improvised explosive device" went off in "a van loaded with charcoal" and that the area had been cordoned off.
"It was a gory sight when we got there," said Karuna Kolo, who lives near the market and arrived at the scene shortly after the blast. "Many people were in flames."
Unruly crowds tried to attack firefighters deployed to the scene, accusing them of arriving too slowly and hindering their efforts to put out the raging blaze, according to multiple witness accounts.
Victims were taken to the State Specialist Hospital, where an AFP photographer saw the bodies of 15 people killed in the blast, while witnesses said the toll could be much higher.
According to Aliyu Aliyu, who identified himself as a member of a vigilante force working with the military to help fight Boko Haram, the explosion was so powerful it sent body parts flying onto the roofs of adjacent market stalls.
Some victims were discovered "without heads and limbs". While there was no immediate claim of responsibility, blame was likely to fall on Boko Haram, which was founded in Maiduguri more than a decade ago and has killed thousands during a five-year uprising.
Attacks in the city were once a daily occurence but a huge military offensive launched last year and backed by the vigilantes had some success in flushing the insurgents out of the city into the remote corners of Borno state, of which Maiduguri is the capital.
But those gains appear to have been lost following a series of attacks in the city this year targeting civilians and the security services.
A bomb ripped through a crowded market in January. In March, hundreds of Islamists stormed the military's Giwa Barracks in Maiduguri, a notorious army prison, and set free scores of their brothers in arms.
The insurgents' kidnap of more than 200 schoolgirls in April from the remote town of Chibok in Borno provoked international outrage and drew unprecedented global attention to the Islamist uprising.
Tuesday's attack came less than 24 hours after Nigeria's military said it had broken up a Boko Haram intelligence cell and arrested its leader, alleged to have taken part in the abduction of the schoolgirls.
A defence headquarters statement said that troops had found the cell headed by a businessman "who participated actively in the abduction".
Of the 276 girls seized, 57 have escaped while 219 are still missing. The businessman, identified as Babuji Ya'ari, who was also a member of a civilian youth group that worked along with the military, popularly known as Civilian JTF (Joint Task Force), allegedly used his position as a cover to work for the militants, it said.
There was no independent confirmation of the claim. Boko Haram Islamists are blamed for killing thousands since 2009, but the first half of this year has been the bloodiest stretch of the insurgency, with more than 2,000 people killed.
An attack on churches on Sunday near Chibok blamed on Boko Haram gunmen killed 54 people, an official has said.
They hurled explosives into churches, torched buildings and fired on worshippers as they tried to flee, residents said.
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