Terror attack can't be ruled out: police

NSW's police commissioner has stopped short of labelling the hostage drama in Sydney's CBD a terrorist attack but says it can't be ruled out.

Police are still trying to determine how many hostages are holed up with a gunman in the Lindt chocolate cafe in Martin Place.

Part of the city has been in lockdown since just before 10am on Monday, when the siege began and the faces of hostages pushed up against the cafe windows were broadcast.

Asked whether the tense situation was being treated as a terrorist attack, NSW Police Commissioner Andrew Scipione chose his words carefully.

"At this stage it is certainly something that we couldn't rule out," he told reporters on Monday afternoon.

"We have not yet confirmed this is a terrorism related event.

"We are dealing with a hostage situation with an armed offender and we are dealing with it accordingly.

"We are ready to escalate should we need to but at this stage we have vast amount of resources available to us."

A black flag with Arabic writing has been seen through the cafe window.

After a briefing with the prime minister, Mr Scipione said police were still trying to work out a motivation for the siege.

However he confirmed police were using protocols similar to those used in a terrorist attack.

The black flag emblazoned with Islamic writing is being carefully scrutinised by authorities.

Asked about talk of other explosive devices around Sydney, Mr Scipione said the reports they had received to date had proved to be negative.

He said police had looked at the scenario of a lone-wolf attack in the CBD in the past.

The siege came hours after a Sydney man was arrested in a counter-terrorism raid but the Commissioner said the two didn't appear to be weren't connected.