The cause of the explosion was not yet known, police said, but there have been several attacks in the east African port city, popular with Kenyan and foreign holidaymakers, since Kenya sent troops into Somalia in October to crush Islamist militants.

A day before the blast the U.S. embassy warned of an imminent attack on Mombasa and urged all its staff to leave. It also said it had suspended travel to the city by embassy staff until July 1.

The suspect now under arrest was taken to hospital after suffering abdominal and leg injuries in the blast, but early on Monday police handcuffed him to his hospital bed and said they needed to question him further.

"One of those wounded people is assisting us with investigations because he is providing contradictory statements. He is being held as a suspect," said Aggrey Adoli, the Coast regional police chief.

At least 15 people have been killed in grenade attacks in Nairobi and Mombasa, including a security guard at a Mombasa night club. There have also been grenade and gun attacks in northeast Kenya near the Somali border.

Kenya has blamed the attacks on al Shabaab, a Somali rebel group which formally merged with al Qaeda this year and has declared war on Kenya because of its incursion into Somalia.

On Wednesday Kenyan police arrested two Iranians after seizing chemicals they suspected were going to be used to make explosives in Mombasa.

Ahmad Mohammed and Sayed Mousavi were charged at the Nairobi High Court on Monday with being in possession of 15 kgs of explosives and preparing to commit a felony. They denied the charges and were detained until Wednesday, when the judge will rule on their bail application.

One man was killed immediately in Sunday's blast, and two of the eight people injured died later in hospital - a nine-year-old boy with shrapnel in his chest and thigh, and a man.

A crowd had gathered at the night club, situated in a residential area, to watch the Euro 2012 football quarter-final between England and Italy.

TOURISM IMPACT

Tourism organisations criticised the warning by the U.S. embassy, echoing the Kenyan government which said on Sunday it considered the warning an act of "economic sabotage" and urged the embassy to reverse it.

Tourism, one of Kenya's major foreign earners alongside tea and horticulture, earned a record 98 billion shillings in 2011, when visitors from Britain and the United States topped the tourist numbers.

There are signs that tourism revenue could drop this year as the euro zone crisis hits confidence in key markets and foreign governments issue travel alerts over the threat from Somali militants, the government and tour operators have said.

"The latest blast has created even more fear, but still the American embassy, knowing too well how delicate this industry is, should have sought consultations before issuing such an advisory," said Mohammed Hersi, chairman of the umbrella group, the Mombasa and Coast Tourist Association.

"This is a very small country with a small economy. When you give out such an alert in a very sensational manner, it does nothing but hurt the country's economy." (Additional reporting by Humphrey Malalo; Editing by James Macharia and Tim Pearce)

• A Permanent Economic Emergency