Police have since confirmed three people were stabbed, one fatally.
Superintendent David Clayton said officers responded to reports of the auto fire but were confronted by the man "brandishing a knife and threatening them".
Three people were stabbed by the suspect, all of them men, police said.
"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.
Once at the scene police say the man who emerged from the auto attacked officers, before members of the public alerted them to several people who had been stabbed.
Ashton said the attacker was known to the authorities at the state and federal level, mainly due to his relatives who are persons of interest to police.
A man tries to help police, pushing a trolley at the attacker.
In multiple videos that surfaced, a man can be seen trying to stab two policemen who try to make several attempts to wrest the knife from the man.
Officers said they were initially called to a auto fire around 4:20pm (AEDT).
In December 2014, a 17-hour siege in which a gunman took 18 people hostage in a Sydney cafe ended with two hostages dead and the gunman killed by police.
If members of the public have images or video footage that may assist police with their investigation into the Bourke...
About 6pm, Victoria Police Superintendent David Clayton holds a press conference just metres from where the incident unfolded.
The suspected attacker was shot by the police and was taken to a hospital for treatment. One of the victims also died and the two others were admitted to hospital.
Premier Daniel Andrews described today's incident as "an evil and bad thing" and condemned it.
Fully engulfed. Multiple loud bangs."This incident in Bourke Street comes on the second day of the highly-publicised murder trial of James Gargasoulas, who allegedly drove through Bourke Street Mall on January 20, 2017, killing six people and injuring 27 others". It is unknown whether it came from the vehicle or was police gun fire.
"Because he was on his stomach, they turned him over to see if he's all right, he was still alive", the witness, Markel Villasin, told Australian Associated Press.