A car bomb claimed by the Islamic State of Iraq and the Levant (ISIL) group has exploded in a busy market in an Iraqi town, killing at least 115 adults and children celebrating the end of the Muslim fasting month of Ramadan, police have said.

About 170 people were also wounded by the blast in Khan Bani Saad, a predominantly Shia town in Diyala province. 

ISIL claimed responsibility for the attack on Twitter and said the car was carrying around three tonnes of explosives. The group said Shias were the target.

Angry crowds went on the rampage after the explosion, smashing the windows of cars parked in the street in grief and anger.

"Some people were using vegetables boxes to collect body parts of kids` bodies," police major Ahmed al-Tamimi told from the site of the explosion, describing the damage to the market as "devastating".

Iraq`s speaker of parliament said the attack had struck an "ugly sectarian chord".

Salim al-Jabouri said the Sunni ISIL group seeks to destabilise the country by carrying out criminal acts and targeting innocent civilians.

The Diyala provincial government declared three days` mourning and ordered all parks and entertainment places to close for the rest of the Eid al-Fitr holiday to pre-empt any further attacks.