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One person was stabbed to death and two others wounded after they were attacked by a man in the centre of the Australian city of Melbourne on Friday, police said.

A man has been arrested after setting a auto on fire and stabbing three people - one fatally - in central Melbourne, Australia.

Several bystanders and police officers were attacked by an assailant in Bourke Street in central Melbourne on Friday afternoon.

Superintendent David Clayton said officers responded to reports of the auto fire but were confronted by the man "brandishing a knife and threatening them".

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

At a press conference, a police spokesperson said there are no links to terrorism at this stage.

Speaking to the media on Friday night, Chief Commissioner Graham Ashton said in light of Friday's incident, he had asked police to re-formulate public safety plans for Stakes Day at Flemington Racecourse, football at AAMI Park and Remembrance Day on Sunday. The condition and injuries of the third person were not disclosed.

"For operational matters we now have the counter-terrorism command and the homicide squad dealing with this matter, and there are ongoing investigations being conducted by the counter-terrorism command", he said.

He said the attacker, 31, was known to "federal intelligence authorities" as well as to Victoria Police.

A second person suffered a head injury and has been taken to hospital. The suspect approached a police vehicle and assaulted an officer by punching him through its window.

A fight then began with local police challenging the man as one bystander used a shopping trolley in an attempt to end the stabbings.

Police shot the suspect in the chest. One of the victims also died and the two others were hospitalized.

Superintendent David Clayton said police responded to reports of a burning vehicle.

The Islamic State group has claimed responsibility for the attack.

Victoria Police said that the attack in the Melbourne CBD is now being treated as a terrorism incident.

"This is an evil and terrifying thing that has happened in our city and our state today and we condemn it", he said.

"A moment later, I heard a loud bang, to me it sounded like a gunshot", she said.

The incident comes as a man is on trial for a 2017 attack on the same street which left six people dead.