An attacker who stabbed a man to death in a terrorist incident in central Melbourne was known to federal intelligence authorities and police.

One man was killed and two others were injured in the attack in Bourke Street which began at about 4pm yesterday.

The 31-year-old attacker was shot in the chest by police and died in hospital.

A man is shown attacking police officers on Bourke Street this afternoon. (AAP)

The suspect was shot in the chest and died in hospital. (9news)

BOURKE STREET ATTACK: Brave passer-by pushes trolley at attacker

Victoria Police Commissioner Graham Ashton said police would not reveal the attacker's name at this stage, but said he was known by officers largely because of members of his family.

A map of Melbourne CBD (Nine)

"We are treating this as a terrorism incident,"Mr Ashton said.



"Initially that person didn't have any identification on them but we believe we now have confirmation of the identity of that person."



Mr Ashton said the counter-terrorism unit was investigating and revealed he'd come to Australia from Somalia in the 1990s, lived in Melbourne's northwest and was known to police through relatives who were persons of interest.

The suspect had a history with cannabis, theft and driving offences.



Islamic State claimed responsibility for the attack late on Friday night, saying on the group's Amaq news website that one of its fighters carried out the attack, but providing no evidence for the claim.

The car on fire near Target on Bourke Street. (9NEWS)

Mr Ashton said there was no evidence the attack had any connection to last year's Bourke Street incident which is currently before court.

The 31-year-old began his rampage by setting fire to a car before going after members of the public.

The car contained several barbecue-style gas bottles, which hampered attempts to extinguish the blaze quickly.

Video shows the man wielding a knife and attacking a group of police officers near the intersection of Swanston Street.

The terror suspect's vehicle had gas bottles inside when it was set alight. (AAP)

He had stabbed three other people before attacking police.

One of the victims died at the scene and he is yet to be formally identified.

A 26-year-old and a 58-year-old have been taken to hospital with non-life threatening injuries.

One of the injured is Tasmanian man Rod Patterson, who is being hailed a hero.

Superintendent David Clayton updating the media on the attack this evening. (AAP)

His wife Maree posted on Facebook he is "doing OK".

"Unfortunately we got caught up in the attack in Bourke Street this afternoon and Rodney was hurt — good news is he is in a great hospital and doing OK given the circumstances — can’t take calls at the moment but will speak to everyone when I can,” she wrote.

Tasmanian MP Will Hodgman heaped praised on the "brave Tasmanian".

"Our thoughts are with a brave Tasmanian, Rod Patterson, his family and friends. A nicer bloke you wouldn’t meet. It’s not surprising he would step in to help others. We all wish him well," he said.

Prime Minister Scott Morrison praised the bravery of the police and bystanders and said Australia would 'never be intimidated by these appalling attacks and go about or lives and enjoy the freedoms the terrorists detest.

Premier Daniel Andrews described the attack as a "evil, terrifying thing".

Police continue to urge the public to avoid the centre of the city. Hundreds of officers and emergency services remain at the scene.

The opening ceremony for the Myer Christmas Windows was cancelled in wake of the incident.

There is no traffic access from Swanston Street to Exhibition Street, VicRoads said in a statement.

Witnesses have told 9News they heard a loud bang before the car burst into flames. (9NEWS)

"The road will be re-opened when investigations are complete and it's safe to do so."

The roads will be likely be blocked until at least 8am on Saturday.

Witnesses are being urged to come forward to police at Melbourne West Station, or submit video to investigators here .

BOURKE STREET ATTACK: What we know

- Police responded to reports of a vehicle on fire in Melbourne's CBD about 4.10pm on Friday. The utility was found alight on the corner of Bourke and Swanston streets, a busy shopping area in the heart of the city.

- Officers were confronted by a man brandishing a knife and making threats. Passers-by told them three members of the public had been stabbed. A man later died at the scene, two other victims are in hospital.

Crowds are being told to avoid the Bourke Street area. (9NEWS)

The city centre came to a complete stop as the shocking incident unfolded. (9NEWS)