Television stations said up to four gunmen opened fire on Bhatti at close range as he left his Islamabad home with his niece on his way to a cabinet meeting, The Guardian reports.
The gunmen pulled Bhatti's niece and guard out of his vehicle, and then shot him several times inside the car. The minister was rushed to Shifa Hospital where he was declared brought dead.
Prime Minister Yousaf Raza Gilani was at the hospital, consoling relatives when reports last came in.
Bhatti, a Christian and a member of the ruling Pakistan People's Party, was an outspoken advocate of reforms to Pakistan's controversial blasphemy laws, and his murder comes two months after another PPP politician and former Punjab Governor Salmaan Taseer was gunned down just a few miles away.
Bhatti had joined Taseer in championing the case of Aasia Bibi, a Pakistani Christian woman who was sentenced to death last November for allegedly committing blasphemy against Prophet Muhammad.
After shooting Bhatti, the assassins escaped after leaving behind pamphlets of a Taliban-affiliated group. According to a report, the pamphlets were signed by a group named "Fidayeen e Muhammad" and "al-Qaida in Punjab", strongly suggesting a link between the killing and the blasphemy controversy.
Human rights campaigners reacted with anger and dismay to Bhatti's assassination, calling it a further sign of crumbling tolerance in Pakistan, which also highlighted the chronic failure of President Asif Ali Zardari's government to safeguard liberal voices in the country.
"Shahbaz Bhatti was one of the few people in the government who took a brave and principled position on the blasphemy law. It appears like Salmaan Taseer before him that he has been killed for espousing this position," said Ali Dayan Hasan of Human Rights Watch.
"This bodes ill for a tolerant Pakistan and renews questions about the government's cowardly abandonment of those within its ranks who took a stand for tolerance," rued Hasan, adding that Bhatti's assassination raised fresh questions about the safety of Sherry Rehman, another PPP parliamentarian who also championed reform of the blasphemy laws, and who has been living in semi-hiding since January after receiving death threats.