An undisclosed number of people have been taken hostage by an armed man at a café in the centre of Sydney.
Hundreds of armed police have sealed off the busy Martin Place in the city's central business district.
Australian Prime Minister Tony Abbott said it was unclear if the siege at a Sydney café, where hostages are being held, was politically motivated.
"We don't yet know if this is politically motivated, although there are some indications that it might be," Abbott told reporters in Canberra.
"This is a very disturbing incident. I can understand the concerns and anxieties of the Australia people," Abbott said, without providing any information on the unfolding siege.
Australian police said they had not had direct contact with an armed offender holding an undisclosed number of people hostage at a cafe in central Sydney.
"We have moved to a footing that would be consistent with aterrorist event," New South Wales Police Commissioner Andrew Scipione told reporters in Sydney.
Australia, which is backing the United States and its escalating action against Islamic State in Syria and Iraq, is on high alert for attacks by radicalised Muslims or by home-grown fighters returning from fighting in the Middle East.
Part of Martin Place, home to the Reserve Bank of Australia, commercial banks and close to the New South Wales state parliament, has been closed off by armed police.
Live television footage showed patrons inside a cafe standing with their hands pressed against the windows. A black flag similar with Arabic writing on it was also visible.
Dozens of police including a SWAT team were setting up and a couple of hundred people were being held back by cordons.
Trains and buses were stopped and roads were blocked in the area, with train operators saying there had been a bomb threat at Martin Place.
NSW Police tweeted: "A police operation is underway in Martin Place, Sydney's CBD. People are advised to avoid the area."