The fire was started by demonstrators protesting the possibility of U.S. retaliation for the Sept. 11 terror attacks that killed thousands, and in support of the ruling Taliban's refusal to hand over Osama bin Laden, a top suspect.
Meanwhile, American and Pakistani officials reached broad accord on a plan for attacks on bases inside Afghanistan, Pakistani sources said.
In northern Afghanistan, heavy new fighting was reported as an opposition alliance pressed on with its bid to seize territory from fighters of the Taliban, the hard-line Islamic movement that governs the country.
Shouting "Long Live Osama!" and "Death to America!" the protesters burned a U.S. flag and an effigy of President Bush before storming the old embassy compound. The building has been abandoned since 1988.
Gray smoke billowed into the sky after about five vehicles were set afire in the embassy compound, and a several men used hammers to remove the large circular U.S. seal above the front entrance. Taliban authorities eventually dispersed the protesters, and the vehicle fires were put out.
In Pakistan's capital, Islamabad, senior Pakistani sources said Pakistani and U.S. defense and intelligence officials had reached broad agreement on an anti-terror progra that included a plan to attack bases in Afghanistan, but that some sticking points remained.
In Karachi, Pakistan, a hand-grenade was lobbed at a site where anti-terrorism activists were to hold a demonstration Wednesday. The pro-Musharraf rally had not begun, but people were gathering. Police said there were 12 injuries. One of the injured was in serious condition, police said.
Speaking on condition of anonymity, the officials said both sides want to minimize the use of ground forces in any strike. They also said some differences had emerged during talks that began Monday between high-ranking Pakistani officials and an American delegation including senior defense and intelligence representatives.
The points of disagreement include whether or not to lend support to the opposition alliance, something about which Pakistan has expressed public misgivings. Other points of contention: what action is warranted against Pakistan-based militant groups; and whether or not the United Nations should approve any operation against Afghanistan.
Some differences were resolved Tuesday when the U.S. delegation members held a 40-minute meeting with Pakistan's president, Gen. Pervez Musharraf, the sources said without specifying which points had been resolved.
However, banking sources said the State Bank of Pakistan ordered banks to freeze assets of 27 groups suspected of terrorist links. They include two Pakistan-based groups the Al-Rashid Trust and the Harkat ul-Mujahideen, a militant group fighting Indian rule in the disputed Kashmir region.
A final round of U.S.-Pakistani talks was taking place Wednesday in Islamabad to try to iron out remaining differences. The discussions were to have ended Tuesday, but were extended.
Anti-government protests have been held in cities across Pakistan since Musharraf pledged to support U.S. military action in Afghanistan.
In northern Afghanistan, new battles broke out in the provinces of Samangan and Balkh between Taliban and opposition fighters. Mohammed Ashraf Nadeem, a spokesman for the opposition's northern alliance, said both sides used artillery, rocket launchers, tanks and machine guns, but that neither had managed to take over new territory.
Nadeem, reached by telephone from Kabul, said Taliban had rushed 3,000 new troops to the region from Kandahar, the southern city where the Taliban are based.
No casualty toll was immediately available, and it was not possible to independently confirm his account of the fighting.
Also Wednesday, Pakistan's minister for frontiers said he did not rule out opening the border to refugees from Afghanistan in case of an attack or other crisis.
"There is no plan to open the border," said Abbas Sarfraz, minister for the frontier regions. "However, within Afghanistan, if the situation becomes untenable, or if there is an attack, purely for humanitarian reasons, we will contemplate that."
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