A suicide attack on an Air Force bus killed eight people on Thursday as security forces said they wiped out up to 70 militants in northwest Pakistan, fuelling talk President Pervez Musharraf would invoke emergency powers to put off elections.
Nuclear-armed Pakistan is going through a period of intense uncertainty in the run up to a vote due in January that is supposed to transform the country into a civilian-led democracy.
With reference to extremists and terrorists, it's a bad situation, said Javed Iqbal Cheema, head of the Interior Ministry's Crisis Management Cell.
It's a very serious threat to Pakistan's internal security.
The Supreme Court added to tensions on Thursday by dragging out hearings on whether U.S. ally General Musharraf was eligible to have stood for re-election while still army chief in a vote in parliament that he won easily early last month.
The Karachi stock exchange's benchmark index dropped nearly three percent on Thursday, compounding declines earlier this week as investors turned tail in a market that is still 38 percent up since the start of the year.
Before the market opened, a suicide bomber rammed a bus and killed eight personnel on their way to an air base in Sargodha in the central province of Punjab.
Police said they had found the head of the bomber, and circled blood stains on the road with white chalk, while the handlebars of a motorbike used by the attacker lay on the tarmac.
Separately, troops killed up to 70 militants as fighting flared in Swat valley in North West Frontier Province, where more than 180 people have died since last week as the military battles a pro-Taliban movement seeking to impose strict Islamic law.
The latest violence coincided with a visit by Admiral William Fallon, commander of U.S. Central Command, for talks with the Pakistani military leadership.
Nearly 800 people have been killed in militant-linked violence and there have been more than 22 suicide attacks in the four months since Pakistani commandos stormed the Red Mosque in the capital, Islamabad, to crush a Taliban-style movement.
Al Qaeda leaders Osama bin Laden and Ayman al-Zawahri, in audio and video tapes released in September, exhorted followers to wage war on Musharraf and Pakistan's security forces.
The last battle between Islam and the infidels is on. On the one side is Sheikh Osama, may Allah keep him safe, Maulvi Faqir Mohammad, one of the most wanted militants in Pakistan told approving ranks of fighters in Bajaur tribal region, near Swat.
We assure him and Mullah Omar, and mujahideen all over the world that we stand solidly behind you.
Yet investors have been more worried about the Supreme Court destabilizing Musharraf, who came to power in a coup eight years ago, than the burgeoning militant threat.
The court said it will adjourn after Friday's session until November 12 -- just three days before Musharraf's present term expires, with parliament also coming to the end of its term.
Constitutional experts say he can carry on as president after November 15, but doubts over his position and how he will react if the ruling goes against him have heightened apprehensions.
This bench will not be intimidated by any threats, Justice Javed Iqbal said, after lawyers noted warnings made by ministers that authoritarian steps could follow any adverse ruling.
Most analysts and foreign diplomats doubt whether the decision will go against Musharraf, and reckon the judges will fudge the ruling, possibly by binding the president to seek a fresh endorsement from the next parliament.
A Western diplomat said if it does go against him all bets are off as to how Musharraf conducts himself.
Musharraf has promised he will quit the army if he gets a second term, and says he is committed to holding elections.
As part of a transition to civilian-led democracy he allowed opposition leader and former prime minister Benazir Bhutto to return from self-imposed exile without fear of being prosecuted for old corruption charges she says were politically motivated.
The government is determined not to permit back Nawaz Sharif, the prime minister Musharraf ousted. Sharif was put on a flight to Saudi Arabia when he tried to end his exile in September, and diplomats say that his absence means the vote won't be fair.
Bhutto flew to Dubai on Thursday to see her family, a day after she put off the trip citing fears Musharraf could impose an emergency. A spokesman said she will be gone up to four days.
The stand taken by Musharraf and Bhutto against the militancy swamping Pakistan has made them prime assassination candidates.
Seven people were killed in a suicide attack on Tuesday less than a kilometer from Musharraf's army residence in the garrison city of Rawalpindi, which neighbors Islamabad.
A suicide bomb attack in Karachi killed 139 people at a procession on October 19 to mark Bhutto's return.
(Additional reporting by Asim Tanveer, Kamran Haider, Zeeshan Haider, Augustine Anthony and Ovais Subhani)