One person has died after a knife-wielding terrorist stabbed three people in Melbourne.
The attack during the afternoon rush hour brought the centre of Australia's second largest city to a standstill.
Hundreds of people watched from behind barricades as police tried to apprehend the attacker.
Officers said the man got out of a pick-up truck, which had caught ablaze, and attacked three bystanders with a knife.
He also attempted to attack police who arrived on the scene, before being shot in the chest by an officer. He died in hospital.
One of the victims also died, while the two others were admitted to hospital.
Police said the attacker's vehicle contained several barbecue gas cylinders in the back. A bomb squad rendered them safe.
Victoria Police Commissioner Graham Ashton said the suspect, originally from Somalia, was known to police and the incident was being treated as terrorism.
"From what we know of that individual we are treating this as a terrorism incident," he told reporters, adding that the police counter-terrorism command was working on the case with homicide detectives.
"He's known to police mainly in respect to relatives that he has which certainly are persons of interest to us, and he's someone that accordingly is know to both Victorian police and the federal intelligence authorities," he said.
The Islamic State group claimed the attack in a statement released through its Aamaq media arm.
It said the man was "one of Islamic State fighters" and had responded to IS calls for attacks in countries that are part of the international coalition fighting the militants in Syria and Iraq.
The attack occurred on the eve of a busy weekend in Melbourne, with a major horse race scheduled for Saturday and a national league football match the following day. Sunday is also Remembrance Day, when memorial ceremonies for the First World War are held.
Mr Ashton said police were "doing security reassessments of these events in light of what's occurred", but there was "no ongoing threat we're currently aware of in relation to people surrounding this individual".
Prime minister Scott Morrison condemned the "evil and cowardly attack".
"Australians will never be intimidated by these appalling attacks and we will continue to go about our lives and enjoy the freedoms that the terrorists detest," he said.
One witness said one of the victims, believed to be a man in his 60s who later died, was stabbed in the face, and that desperate efforts were made to save him.
"Because he was on his stomach, they turned him over to see if he's all right, he was still alive," Markel Villasin told Australian Associated Press.
"He was breathing and he was bleeding out."
Video from the scene showed a man swinging a knife at two police officers near a burning car before he was shot.
In December 2014, a 17-hour siege in which a gunman took 18 people hostage in a Sydney cafe ended with two hostages dead and the gunman killed by police.
Though the erratic gunman demanded that police deliver him an IS flag at the outset of the crisis, there was no evidence he had established contact with the militant group.
However, at a later inquest, the coroner of New South Wales said the gunman's actions fell "within the accepted definition of terrorism".
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