Police have since confirmed three people were stabbed, one fatally.
Video shows the man attempting to slash police officers with a large knife before falling to the ground.
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.
Australian police said one person died at the scene and another two others were being treated for their injuries.
"We don't believe there is an ongoing threat at this stage, but certainly we are treating it as a terrorism incident", Victoria Police Commissioner Graham Ashton said later Friday.
Footage from the scene show a man making stabbing gestures at two uniformed officers near a burning auto before he was shot.More news: Kyrie Irving lifts Celtics from horrific start to incredible comeback over Suns
Witnesses said the man began attacking pedestrians near a pickup truck apparently belonging to the attacker which had exploded into flames, according to news agency AFP.
The suspect was was hospitalized in critical condition.
Nearby police arrived shortly at the location and the man, wielding a knife, attempted to assault police officers.
However, the police has clearly refuted any links of terrorism with the incident.
Clayton said police had arrived at Bourke Street, a busy shopping thoroughfare, in response to a vehicle fire.
Police confirm one person has died following Bourke Street Mall attack.More news: Star Wars: Diego Luna Will Star in a Rogue One Prequel Series
The man has been arrested and is under police guard in hospital.
"They were around him trying to take the knife out of his hand - I'm pretty sure it was a kitchen knife", he said.
Victoria state Premier Daniel Andrews says the attack was "an evil and terrifying thing that has happened in our city and state today".
"I kept watching", said witness Tony Nguyen, after what he described as a "car bomb".
One witness, Sarah Krug said she was heading to the night noddle markets when "all hell broke loose".
Footage circulating on social media shows a vehicle, which appears to have crashed into shop fronts, on fire.More news: Man Crashes Car Before Stabbing People in Melbourne; 1 Dead
Police have asked members of the public to send images and video of the incident in order to help with their investigation.
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