He was travelling to work through a residential district when his vehicle was sprayed with bullets, police said.
Mr Bhatti, the cabinet’s only Christian minister, had received death threats for urging reform to blasphemy laws.
In January, Punjab Governor Salman Taseer, who had also opposed the law, was shot dead by one of his bodyguards.
The blasphemy law carries a death sentence for anyone who insults Islam. Critics say it has been used to persecute minority faiths.
‘No security escort’
The Vatican condemned the murder of the Catholic politician as an “unspeakable” act of violence.
Mr Bhatti, 42, a leader of the ruling Pakistan People’s Party (PPP), had just left home in the capital when three to four gunmen surrounded his vehicle and sprayed it with bullets.
One witness, Gulam Rahim, told AP news agency that two of the attackers had opened the door and tried to pull Mr Bhatti out, while another man fired a Kalashnikov into the car.
He was rushed to the nearby Shifa hospital, but was pronounced dead on arrival, Dr Azmatullah Qureshi told the AFP news agency.
The gunmen, who were wearing shawls, escaped in a white Suzuki car, according to witnesses.
Police chief Wajid Durrani told reporters that the minister was not accompanied by his guards when the attack happened, although he said Mr Bhatti had been provided with a security detail.
“The squad officer told me that the minister had directed him to wait for him at his office,” said Mr Durrani, reports AFP news agency. “We are investigating the matter from different angles.”
No group has said it was behind the attack, but pamphlets purporting to have been issued by al-Qaeda and Tehrik-i-Taliban Punjab, a branch of the Taliban in Pakistan’s most populous province, were found at the ambush site.
The pamphlets warned that anyone who criticised the blasphemy law would be shot.
A Taliban spokesman later said they carried out the attack, reports Reuters news agency.
Security has been stepped up on all main roads in Islamabad.
This is a concerted campaign to slaughter every liberal and humanist voice in Pakistan”
End Quote Farahnaz Ispahani Pakistan presidential aide
In January, Mr Bhatti told the BBC he would defy death threats he had received from Islamist militants for his efforts to reform the blasphemy law.
“I was told that if I was to continue the campaign against the blasphemy law, I will be assassinated. I will be beheaded. But forces of violence, forces of extremism cannot harass me, cannot threaten me,” he said.
A government spokesman condemned the assassination.
“This is a concerted campaign to slaughter every liberal, progressive and humanist voice in Pakistan,” Farahnaz Ispahani, an aide to President Asif Ali Zardari, told the AP news agency.
“The time has come for the federal government and provincial governments to speak out and to take a strong stand against these murderers to save the very essence of Pakistan.”
Governor Taseer was shot dead on 4 January, also in Islamabad, by one of his own police bodyguards. The killer has been feted throughout the country as a hero.
The governor had backed a private member’s bill in parliament by Sherry Rehman, a female MP, to amend the blapshemy law in an attempt to make miscarriages of justice less likely and remove its death penalty.
But in the face of strident popular opposition, the federal government said it would not support the proposed reforms.
Ms Rehman said last month she was receiving death threats every half hour by e-mail and telephone.
Pakistan’s blasphemy law has been in the spotlight since a Christian, Asia Bibi, was sentenced to hang last November for insulting the Prophet Muhammad. She denies the charge.
The mother-of-five had been picking berries alongside local Muslim women, when a row developed over sharing water.
Days later, the women complained that she had made derogatory remarks about the Prophet Muhammad.
Although no-one convicted under the blasphemy law has ever been executed, more than 30 accused have been killed by lynch mobs.
Critics say that convictions under the law hinge on witness testimony, which is often linked to grudges.
About 1.5% of Pakistan’s 185 million population is Christian.