At least five hostages were released or escaped since the midmorning siege began, with panicked cafe workers and customers seen running into the arms of paramilitary police.
Police said they knew of one armed assailant involved in the hostage taking but said there could be more.
Police, including paramilitary officers, cordoned off several blocks around the cafe as negotiators tried to defuse one of the biggest security scares in Australia for decades. Snipers and a SWAT team took up positions around the cafe and police helicopters flew overhead.
About 15 hostages could still be seen inside the cafe, said Chris Reason, a reporter at Channel Seven, whose office is opposite the cafe.
“From inside Martin Place newsroom we can see gunman is rotating hostages, forcing them to stand against windows, sometimes 2 hours at a time,” Reason said on Twitter.
Prime Minister Tony Abbott, who has warned of militant plans to strike Australian targets, said there were indications the hostage taking was politically motivated.
“This is a very disturbing incident. I can understand the concerns and anxieties of the Australian people,” Abbott told reporters in Canberra.
Australia’s Channel Ten said it had spoken to two of the hostages inside the cafe and the man holding them had made a series of demands.
“Our #TenNews team have spoken directly to 2 hostages inside. They are confirming 2 demands from the perpetrator,” the network tweeted.
“He needs the ISIL flag to be directly delivered to the cafe; And his 2nd request is to speak to the Prime Minister. The Channel quoted the hostages as saying that they were told by the captor that there are 4 bombs... two inside the Lindt cafe at Martin Place – and two further in the Sydney CBD.”
There was no confirmation about bombs from police by late yesterday.
Australia, a staunch ally of the United States and its escalating action against the Islamic State in Syria and Iraq, is on high alert for attacks by homegrown militants returning from fighting in the Middle East.
“We have moved to a footing that would be consistent with a terrorist event,” Andrew Scipione, police commissioner for the state of New South Wales, told reporters.
News footage showed hostages holding up a black and white flag displaying the Shahada, a testament to the faith of Muslims. The flag has been popular among Sunni Islamist militant groups such as Islamic State and al-Qaeda.
The incident that started at about 9.45am local time (5.45am in Bangkok) forced the evacuation of nearby buildings and sent shock waves around a country where many people have started to turn their attention to the Christmas holiday following earlier security scares.
In September, anti-terrorism police said they thwarted an imminent threat to behead a random member of the public and days later, a teenager in the city of Melbourne was shot dead after attacking two antiterrorism officers with a knife.
Evacuating by ladder
“I walked up to the door and then everyone was sitting down and the door’s locked – which is pretty weird because it’s never locked – and there was one guy walking around with a hat and a beard,” a man who identified himself as Bruno, a worker at the cafe, told the Australian Broadcasting Corp, referring to the suspected assailant. He said he then turned away.
The Reserve Bank of Australia said staff had been locked down inside the building and were all safe. India’s parliamentary affairs minister said an Indian IT professional may be among the hostages.
Meanwhile, the Thai Consulate General in Sydney suspended its services as recommended by the Australian government after the siege began.
Prime Minister Prayut Chanocha, meanwhile, said he did not think the incident would have any impact on Thailand’s security, as the Kingdom is not in direct conflicts with any other country.
Thailand was also ready to prevent any bids to attack the country, he said, adding that he hoped the hostage situation would b solved as soon as possible.
Consul General Teerathep Promvongsanon said the Australian government had asked government offices, both local and foreign, as well as businesses in the area to close for a day for safety reasons.
Teerathep said the consulate had warned Thai nationals in Sydney to avoid the area, as well as keep in touch with the Thai community and networks, as well as follow guidelines issued by local authorities. His office meanwhile denied reports a Thai was among the hostages.
There are some 20,000 Thais living in Sydney.
Thanasarn Thongkao, the Thai owner of Batch Espresso restaurant near Lindt cafe, said he called the restaurant to instruct all members of staff go home immediately.