Reports said several hostages were injured and two were dead. It was not known if the gunman who took the people hostage, Man Haron Monis, was alive or dead.
Monis is an Iranian refugee with a criminal past, Australian police said late on Monday night. A self-styled Sheikh, he had been accused of sexual assault and was known for sending hate mail to families of Australian soldiers killed overseas.
Mounis kept over 30 people hostage in Lindt Chocolate Cafe in Martin Place, the city's financial area. The gunman had warned about four bombs planted in the city. He has also reportedly demanded to speak to Prime Minister Tony Abbott and an Islamic State flag.
Five hours into the siege, which began at around 9.45 am local time (4.15 am IST), five hostages had managed to escape.
Monis had forced the rest to hold up a flag displaying the Shahada - a profession of faith in Islam. The flag is popular among Sunni Islamist militant groups such as Islamic State and al Qaeda.
As the crisis deepened, snipers and a SWAT team barricaded Martin place. Police helicopters circled overhead. Negotiators established contact with Monis.
The Reserve Bank of Australia locked its staff in the building. The nearby US consulate and the Sydney Opera House were evacuated. The Indian consulate, about 400 m from the cafe, was closed down.
Concerns about lone-wolf attacks have been on since September, when a high alert was issued after an Islamic State spokesman urged supporters to launch attacks in Australia and the West. Australia is an ally of the US, which is conducting airstrikes against the IS in Iraq and Syria.
"I am deeply concerned about the threat that lone wolf terrorism poses to people," Prime Minister Tony Abbott had said.
Today, after the hostage crisis started, Mr Abbott said the man perpetrating the crisis could have political motivations.
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