The death of Abdullah Mehsud is a boost to the government amid intense fighting between security forces and militants near the Afghan frontier and a run of homicide attacks across Pakistan.
Armed intelligence agents cornered Mehsud and three other men at the home of an Islamist politician in the southwestern town of Zhob, police officials said.
"My information is that Abdullah Mehsud killed himself," Zhob police chief Atta Mohammed told The Associated Press. "Thanks be to God that only he was blown up and our men were safe."
Federal Interior Ministry spokesman Javed Iqbal Cheema confirmed Mehsud's death, but provided no details.
The one-legged militant was released from the U.S. jail for terror suspects at Guantanamo Bay, Cuba, in March 2004 after he was captured in Afghanistan fighting for the Taliban.
He quickly took up arms again, and became a leader of militants in the South Waziristan region on the Afghan border, and was wanted for the kidnapping of two Chinese engineers later that year.
One of the Chinese, who had been working on a dam project, was killed while the other was rescued alive in an operation by Pakistani commandos.
A Zhob police official said security forces raided the house of Sheikh Mohammed Ayub, a leader of the Jamiat Ulema-e-Islam party, after learning that militants from Waziristan had arrived there late Monday evening.
Agents issued warnings to Mehsud to surrender but he refused and detonated the grenade, the official said on condition of anonymity because he was not unauthorized to speak on the record.
Police chief Atta Mohammed identified the three other men, who were taken into detention, as Sheikh Azam, Shamshir Khan and Abdur Rehman Mehsud. Ayub was not at home at the time, he said.
Meanwhile, before dawn Tuesday, militants launched fresh attacks on Pakistani troops stationed at roadside security posts in North Waziristan, an intelligence official said. Troops returned fire, triggering gunfights. No casualties were reported, the official said on condition of anonymity because he was not authorized to make media comments.
Militants also detonated dynamite at a municipal office late Monday in Miran Shah, the regional capital, causing damage but no injuries, he said.
Further north, the beheaded bodies of two soldiers abducted the night before were found Tuesday morning in the Bajur tribal area, said Sardar Yousaf, a local government official.
A note found in the hand of one of the slain men said that spies for U.S. President George W. Bush or Pakistan's President Gen. Pervez Musharraf would meet the same fate, Yousaf said.
Violence has flared across Pakistan since a deadly military raid on a radical mosque in the capital Islamabad earlier this month. More than 300 people have died, most of them security forces.
Most of the violence has been in North Waziristan, a tribal region where a 10-month-old peace deal with between the government and militants has broken down and the army has redeployed troops backed by helicopters and artillery.
Officials are trying to resurrect the deal, signed in September by tribal elders who pledged to expel foreign militants and stop cross-border raids into Afghanistan.
However, Washington has described the accord as a failure that gave breathing to Al Qaeda to regroup -- and perhaps plot another big attack on the United States.
Arab, Afghan and Central Asian militants suspected of links with Al Qaeda as well as Taliban and local militants operate in North and South Waziristan.
The area is viewed as a possible hiding place for Al Qaeda chiefs Usama bin Laden and Ayman al-Zawahori.
The government has angrily rejected suggestions from U.S. officials that American troops might conduct crossborder raids from Afghanistan on Al Qaeda hideouts in the tribal belt along the frontier.