An attacker who stabbed a man to death in a terrorist incident in central Melbourne was known to federal intelligence authorities and police.
The knifeman parked his ute in Bourke Street just after 4pm on Friday and stabbed three people. He was shot as he tried to stab two officers and died later in Royal Melbourne Hospital.
"We are treating this as a terrorism incident," Victoria Police Chief Commissioner Graham Ashton said on Friday night.
"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 he couldn't name the attacker but he 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 Islamic State group late on Friday said one of its fighters carried out the assault but provided no evidence for the claim, news agency Reuters reported from Dubai.
Witnesses said the attacker stabbed the victim, believed to be aged in his 60s, in the face.
A white sheet covered the man as he lay on Bourke Street in the rain. He was still to be identified with police in the process of contacting his family.
"Three people have been stabbed, unfortunately one is deceased at the scene, two other victims are currently in hospital," Superintendent David Clayton told reporters at the scene.
The other two victims, both men, are recovering from non-life-threatening injuries, Mr Ashton said.
Nearby KFC worker Markel Villasin told AAP desperate efforts were made to save the victim who died.
"Because he was on his stomach, they turned him over to see if he's alright; he was still alive," he told AAP.
"He was breathing and he was bleeding out."
Footage from the scene shows a man earlier swinging a knife at two uniformed officers near a burning car before he was shot.
"(Officers) were confronted by a male brandishing a knife and threatening them," Supt Clayton said.
Police are not looking for anyone else in relation to the events but are asking for witnesses to come forward.
Mr Villasin said bystanders were screaming at police to shoot the knifeman.
"They were around him trying to take the knife out of his hand - I'm pretty sure it was a kitchen knife," he said.
"I don't know what the police were doing, for a good two to three minutes they were trying to grab him, tackle him down when a lot of people were screaming ... 'just f***ing shoot him, shoot him'."
Police initially responded to reports of a vehicle on fire at the corner of Bourke and Swanston streets. The dual cab Rodeo ute was quickly extinguished.
Another bystander told AAP he was walking on Swanston Street when he heard an explosion and then saw a "big dude punching into the police car".
"The cops were trying to hit him with batons and he wasn't going down," he said.
Two civilians became involved as well as two police, trying to stop the man.
Streets around the crime scene would remain cordoned off until 8am on Saturday, Mr Ashton said.
Prime Minister Scott Morrison condemned the "act of terrorism" as evil and cowardly and praised the police who responded.