ISLAMABAD (AFP) - Pakistan's Supreme Court ruled on Friday that President Pervez Musharraf can stand for re-election this weekend, but ordered that the result cannot be announced until it resolves legal challenges.

The decision effectively leaves a sword hanging over the head of Musharraf, a key US ally, while the court decides whether it will validate the result of Saturday's crunch vote, which he is widely expected to win.

It came a day after he struck a deal with former premier Benazir Bhutto that would pave the way for a power-sharing arrangement aimed at ending Pakistan's chronic political instability.

Musharraf, a lynchpin in the US "war on terror," seized power in a coup in eight years ago and is controversially standing for another five-year term in office while still holding down his position as army chief.

Opponents challenged the validity of the election, but the Supreme Court's ruling clears the way for the vote, carried out by an electoral college of the national and federal parliaments, to go ahead.

"The bench has unanimously resolved and directed that the election process should proceed as per the schedule announced by the chief election commissioner," chief judge Javed Iqbal said.

"But final notification of the returning candidate will not be issued until the decision of this petition, for which the process is to begin from October 17," he added.

The court was ruling on challenges filed by the vice-chairman of Bhutto's party, Makhdoom Amin Fahim, and by retired judge Wajihuddin Ahmad, who refused to swear allegiance after Musharraf's 1999 power-grab.

The government said it would "honour the decision and will implement it in letter and spirit."

"We look forward to tommorrow's election and are confident the president will get duly elected," deputy information minister Tariq Azeem told AFP.

But candidate Ahmad's lawyer declared it was the "first step to overall victory".

"The court's order has stopped the declaration of the election results of a usurper," lawyer Hamid Khan said.

A senior government official said the decision risked heightening tensions in the volatile nuclear-armed Islamic republic of 160 million people.

"This has accentuated the uncertainty and may trigger instability," the official told AFP on condition of anonymity.

The ruling came with Musharraf expected to formalise a last-minute national reconciliation deal with Bhutto that paves the way for power-sharing and for her planned return from exile on October 18.

The deal gives an amnesty for politicians active in Pakistan between 1988 and 1999 -- effectively clearing Bhutto of the corruption charges that forced her into exile eight years ago.

Bhutto, whose Pakistan People's Party is the country's largest, had earlier threatened to undermine Musharraf's expected victory by pulling her MPs from parliament, after other opposition parties also resigned.

Musharraf has promised to quit his military role by November 15 if he wins the election.

Railways Minister Sheikh Rashid, a close confidant of the president, said the deal was done and that Bhutto had given her assent.

Azeem said the cabinet was expected to give formal approval before sending the pact to Musharraf to sign, adding: "We are almost there."

Musharraf's allies have a majority in the two houses of parliament and four provincial assemblies that will vote for the president, but he would benefit from Bhutto's support ahead of the general election.

A senior party member in Islamabad, PPP lawyer Farooq Naik, confirmed the deal. "We have given it our go-ahead."

The White House made no comment on the agreement and repeated instead its call for "free and fair" elections.

However the United States has been quietly striving for a deal that would bring together two Western-friendly leaders together in a country wracked by violence linked to Osama bin Laden's Al-Qaeda network.