The attacker detonated an explosives vest in the midst of the mourners attending the funeral for a Sunni policeman who had been shot dead on Thursday night, said an officer who declined to be identified because he was not authorized to speak to the media.
Meanwhile, Iraqi Prime Minister Nouri al-Maliki ordered a nationwide freeze on raids against suspected Shiite militiamen. His announcement Friday came one day after Shiite leader Muqtada al-Sadr hinted at retaliation if the arrests of his followers in the Mahdi Army militia did not stop. The militia fought government troops in Basra and Baghdad last week.
Al-Maliki's statement did not mention the Mahdi Army by name or give a timeframe for the freeze, saying only that the move is designed to give a "chance to those who repented and want to lay down their arms."
On Thursday, Iraqi troops killed seven militants and detained 16 in three separate incidents in Basra, a U.S. military statement said Friday.
The attack on the funeral occurred in Sadiyah, a town 60 miles north of Baghdad in the volatile Diyala province.
Most of the victims of the attack - the deadliest in Diyala this year - appeared to be relatives of the dead policemen, the officer said.
Prior to al-Maliki's order to cease raids In Basra, Iraqi special forces captured a suspected militant leader who has been rallying insurgents in the area to fight against coalition forces, the military statement said.
"Intelligence reports have linked the man to the kidnapping and murder of Iraqi Army and ISOF soldiers. He is also believed to be involved in oil smuggling and foreign fighter networks," said the statement, which did not provide any further details.
In a separate firefight, a insurgents engaging Iraqi special forces in the city. The air strike killed two militants, the statement said.
On March 25, Iraqi forces launched a major operation to rid Basra of Shiite militias and criminal gangs that had effectively ruled the city of 2 million people since 2005. But the offensive stalled in the face of fierce resistance from the militiamen and an uprising across the Shiite south spearheaded by the Mahdi Army.
Fighting eased last Sunday when al-Sadr ordered his fighters to stand down under a deal brokered in Iran.
Nevertheless, al-Maliki, himself a Shiite, insisted that the campaign to reclaim Basra was on track and that he would soon go after "criminal gangs" in Baghdad and elsewhere. That vow came Thursday - before he announced a halt to all raids against Shiite militias.
Al-Maliki specified Thursday two Baghdad neighborhoods - Sadr City and Shula - where the Mahdi militia holds sway and where U.S. and Iraqi forces have clashed with militants in recent days.
Both areas remain under a vehicle ban imposed last week throughout Baghdad but which has been lifted elsewhere in the capital.
In other developments:
The violence in Basra erupted as the two top American officials in Iraq were preparing to brief Congress on prospects for further U.S. troop cuts.
U.S. Ambassador Ryan Crocker, who will appear before Congress on Tuesday with top commander Gen. David Petraeus, said he was surprised at the way the Basra campaign unfolded.
"I had the understanding that this was going to be an effort to get down, show they were serious with additional forces, put the squeeze on, develop a full picture of conditions and then act accordingly," he told reporters Thursday. "I was not expecting, frankly, a major battle from Day One."
Still, Crocker said he was encouraged that the Iraqi government was willing to take on Shiite militias, some of which maintain close ties to major political parties in the national leadership.
"Were there problems? There were a boatload of problems, and they still have a long way to go," Crocker added.
In a statement Thursday, al-Sadr complained that although he had called on his militia to stop fighting, the army and police were continuing illegal arrests and attacks against his followers.