The blast shortly before 9:00 am (0700 GMT) came as hundreds of Palestinian prisoners were about to be freed in a delicate deal between Israel and the Lebanese guerrilla movement Hezbollah.

But an Israeli official said the prisoner swap would go ahead as planned.

Around 40 other people were also injured in the attack, a spokesman for the Magen David Adom rescue service told public radio here.

The scene of the blast, close to the junction between Aza Street and Balfour Street in central Jerusalem, was sealed off to reporters but an AFP correspondent said the front part of the number 19 bus had been completely blown out.

David Baker, an official in Sharon's office, said that the attack was proof of the Palestinian Authority's failure to crack down on hardliners.

"Israel has no chance but to wage an uncompromising war against terror," Baker told reporters at the scene.

"This is another example of Palestinians targeting Israelis in the hearts of their cities. The PA is doing aboslutely nothing to fight terrorism."

Sharon was not in his house at the time of the blast but was staying on his ranch in the southern Negev desert, Israeli media reports said.

It was the first suicide attack in Israel since a blast on December 25 near Tel Aviv when four Israelis were killed as well as the bomber.

Four Israelis were also killed two weeks ago when a mother of two recruited by the militant Hamas organisation blew herself up at the Erez border crossing between the Gaza Strip and Israel.

The latest attack brings the overall death toll since the start of the Palestinian intifada in September 2000 to at least 3,726.

The blast came as a German military plane flew in to Cologne from Beirut with the bodies of three Israeli soldiers and reserve colonel Elhanan Tannenbaum. An Israeli aircraft carrying around 30 Arab prisoners and a German national, who all boarded in Tel Aviv overnight, touched down minutes later at the airport.

The arrivals were the first phase in a complicated prisoners exchange deal which will see some 400 Palestinians go free Thursday, a move which victims' groups have warned will endanger Israel's security.