A knife-wielding man has stabbed two people, one fatally, in Melbourne in an attack believed to be linked to terrorism, police said.

The attack during the afternoon rush hour brought the centre of Australia’s second largest city to a standstill.

Police said the man got out of a vehicle, which then caught fire, and attacked three bystanders with a knife before being shot by police.

The suspect died later in hospital. One of the victims also died and the two others were admitted to hospital.

Victoria Police Commissioner Graham Ashton said the suspect, originally from Somalia, was known to police and the incident is being treated as terrorism.

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

Officers were confronted near the burning car by a man “brandishing a knife and threatening them” while passers-by called out that people had been stabbed, he said.

Mr Clayton said investigators did not believe there were any other assailants. The man was shot in the chest by police.

A burnt-out vehicle in Melbourne
A burnt-out vehicle in Melbourne (James Ross/AAP/AP)

He said a bomb squad was making the scene safe.

Victoria Police tweeted a request for witnesses to speak to police and share any images that might help the investigation.

Officers said the car contained several barbecue gas cylinders.

Victoria state premier Daniel Andrews said the attack was “an evil and terrifying thing that has happened in our city and state today”.

Mr Ashton added: “From what we know of that individual we are treating this as a terrorism incident,” adding that the police counter-terrorism command was working on the case as well as 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.”

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”.

One witness said one of the stabbing 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.