I would imagine using a combination of blur horizontal/vertical, along with a clipping mask. You have two layers with the background image, the one on top is blurred and the one below is not. Use the "destination in" blending mode on a helper sprite (clipping mask) to clip the blurred layer to only the section you want blurred, while the rest of the unblurred background shows below. On the layer with the blurred image and clipping mask helper sprite, you want to set the "Force own texture" property to yes.
I can't try it myself at the moment, so not sure if it works. Someone else might be able to contribute a better/simpler way.