The donkeys had been sent across Turkey's south-eastern border with Iraq to ferry vats of smuggled diesel and cigarettes. On Thursday when they came back it was with bodies wrapped in carpets lashed to their sides: the victims of a Turkish air raid that killed up to 35 villagers from this remote region.

In a major embarrassment for Turkey's government, it was forced on Thursday to admit that the dead, originally described by the Turkish army as Kurdish separatist fighters from the banned PKK, were civilians, misidentified by Turkish drones and then bombed on Wednesday evening as they travelled close to the Iraqi border.

A Turkish ruling party spokesman, Huseyin Celik, said the victims "were not terrorists" but smugglers, adding that officials were investigating possible intelligence failures that led to the strikes. He expressed regret for the deaths and suggested the government would compensate the victims.

Television footage shot in the aftermath of the air strike showed mourning mountain villagers, some weeping, ferrying several dozen bodies away from the scene of the attack in trucks. Other images showed a line of corpses covered by blankets on a snow-covered hillside, with a crowd of people gathered around, some with their heads in their hands, crying.

According to local accounts, a group of people from the villages of Ortasu and Gulyazi were crossing the border from northern Iraq when they were blocked by soldiers on the path and then bombed at around 9.30pm on Wednesday.

The attack, which Turkey's largest pro-Kurdish party called a "crime against humanity", sparked clashes between hundreds of stone-throwing protesters and police in Diyarbakir, the largest city in Turkey's restive mainly Kurdish south-east. Police responded by firing water cannon and teargas at the demonstrators. Seven people were detained. One police officer was hurt after being hit by a stone, witnesses said.

"We were on our way back when the jets began to bomb us," a survivor, Servet Encu, told the pro-Kurdish Firat news agency.

It was one of the deadliest attacks since the PKK took up arms in 1984 in a conflict in which more than 40,000 people have been killed.

The smuggling of cigarettes, fuel and even people is common along the Iraqi border but the same routes are also used by Kurdish separatist fighters. Survivors said they were transporting diesel in barrels when they were hit.

Turkey's military said it was investigating the incident. "Since the area where the group was located was often used by terrorists and a movement towards our border was determined, it was evaluated that the area should be held under fire by air force planes," it said.

Local politicians strongly denied that those killed were militants, insisting they were involved in smuggling instead.

"We have 30 corpses, all of them are burned," said Fehmi Yaman, mayor of Uludere in Sirnak province. "The state knew that these people were smuggling in the region. This kind of incident is unacceptable. They were hit from the air."

The pro-Kurdish Peace and Democracy Party (BDP) said 35 people had been killed and party leaders were heading for the area. Its joint chairman, Selahattin Demirtas, announced a three-day period of mourning.

"It is clear there was a massacre. They will try to cover it up … we will not allow them to cover it up," Turkish media reported Demirtas as saying. "This country's warplanes bombed a group of 50 of its citizens to destroy them. This is a war crime and a crime against humanity."

The BDP said it would hold demonstrations in Istanbul and elsewhere to protest at the deaths.

The Turkish military said it had learned that the PKK had sent many militants to the Sinat-Haftanin area, where the strikes occurred in northern Iraq, to retaliate after recent militant losses in clashes. Military units were warned that PKK groups were planning attacks on security force border posts in south-east Turkey, prompting the military to increase border surveillance.

"It was established from unmanned aerial vehicle images that a group was within Iraq heading towards our border," the military said.

The PKK, regarded as a terrorist organisation by Turkey, the EU and the US, launches attacks on Turkish forces in south-eastern Turkey from hideouts inside the remote Iraqi mountains.

In a statement before the latest incident, the National Security Council said that recent security forces operations had dealt a major blow against the PKK and the military would continue to fight decisively against the militants.

Turkey and Iran have often skirmished with rebels in the region and Turkish leaders vowed revenge in October with air and ground strikes after the PKK killed 24 Turkish soldiers in raids on military outposts in south-eastern Turkey.