Flames were seen shooting out of the hotel, a key meeting place for foreigners and one of the most carefully guarded sites in the city, after the powerful blast, which was heard from quite far away.
Police officials said it appeared to be a car bombing but could not confirm it had been a suicide attack. Ambulances were racing to the scene, and it was not immediately known how many people were wounded.
"At least 27 people were killed," local police officer Khalid Khan told AFP.
Another officer at the scene said many people were still trapped in the hotel, which caught fire after the bombing on Saturday night.
The bomb was so powerful that it blew out windows in buildings about one kilometre (a half-mile) away.
An AFP photographer saw at least 20 mutilated bodies amid the carnage at the scene.
The attack came just hours after new President Asif Ali Zardari, who faces a tough challenge in reining in a wave of Islamist militant violence, delivered his first address to parliament.