An 18-year-old terror suspect has been shot dead by counter-terrorism police and two policemen have been stabbed in Melbourne's outer south-east.

Police said the two officers met the 18-year-old Narre Warren man outside the Endeavour Hills police station before he lashed out at the officers with a sharp instrument. He then ran towards the police station and was shot.

Onlookers at the scene — who did not want to be named — said the dead man had been shouting insults at Prime Minister Tony Abbott and the Australian government in general in the moments before he was shot.

The Federal Government says the shooting occurred "in self defence" and the victim was a known terror suspect.

Counter-terrorism police did not consider the youth a major threat, which is why he was invited for a low key meeting outside a police station. But the youth was known to intelligence investigators due to his recent erratic behaviour.

Federal police sources say the AFP officer was stabbed multiple times in the face, shoulder and abdomen.

The two stabbed officers, one from Victoria Police and one from the Australian Federal Police, were working together as part of a joint operation on counter-terrorism between the AFP and Victoria Police. The operation is believed to have been running for the past two to three years.

It is understood the AFP officer had regained consciousness and he was "lucky to be alive", the source said.

The Victorian police office, a senior constable in his late 30s, was stabbed in the arm.

It is understood the Victorian policeman was attacked first before the teenager turned on the federal police officer.

Police say the man was involved in an ongoing investigation, but AFP Commander Bruce Giles would not confirm whether the 18-year-old's passport was among those that had been suspended, as had been reported.

However, he said, reports the man had been displaying Islamic State flags in the lead-up to police contacting him appeared to be correct.


Read more: Terror suspect shot dead after two police officers stabbed in Endeavour Hills