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SYDNEY, AUSTRALIA-A knife-wielding man stabbed three people, one fatally, in Australia's second-largest city on Friday in an attack police linked to terrorism.

The man stabbed three people, killing one, before he was shot by police.

Police later shot the man who threatened officers with a knife and he is in a critical condition under guard at a hospital, Victoria Police Superintendent David Clayton told reporters.

Victoria Police on Friday confirmed they were treating the attack which occurred just before 4:30pm in Melbourne's busy Bourke Street as a terror-related incident.

Police said they were responding to a call reporting a auto on fire in Melbourne's business district but a man waving a knife confronted them when they reached the spot.

A burnt vehicle is pictured at the crime scene following a stabbing incident in Melbourne on November 9, where one person was killed and two others injured in a rush hour stabbing incident.

Chief Commissioner Graham Ashton says the Somalian-born Shire Ali was the brother of a man arrested by police late previous year in relation to committing acts in preparation for a terrorist attack.

Ashton said the attacker was known to the authorities at the state and federal level, mainly due to his relatives who are persons of interest to police.

A third person has also been taken to hospital, although the nature of their injuries is not yet known.

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Supt Clayton said authorities were not looking for any other offenders. "The area has been cordoned off", police said. "Police shot the male in the chest and he is now in a critical condition under guard in hospital".

"And then I heard one loud bang".

The news report above came before police acknowledged that the man was already on the radar of Australian intelligence.

Two other people are in hospital after being stabbed in a busy Bourke Street on Friday afternoon.

"The cops were trying to hit him with batons and he wasn't going down", he said. A bomb squad has since rendered the vehicle safe.

"This is an evil and terrifying thing that has happened", Victoria State Premier Daniel Andrews said.

Islamic State said one of its fighters carried out the knife attack.

Friday's attack is a double blow for the city as it coincides with an ongoing the murder trial of 28-year-old James Gargasoulas, who ploughed his vehicle into crowds in the same area in 2017, killing six people.