Gunmen attacked a restaurant popular with expatriates in the diplomatic quarter of the Bangladeshi capital on Friday and took hostages, including several foreigners, police said.
Eight to nine gunmen attacked the Holey Artisan restaurant in the upscale Gulshan area of Dhaka, and police were preparing to start an operation to rescue the hostages, said Benjir Ahmed, the chief of Bangladesh's special police force.
CNN said 20 people were being held in the restaurant.
Ahmed said the assailants had hurled bombs at police. One policeman was dead and two others wounded by gunfire that erupted as they surrounded the restaurant, police said.
A resident near the scene of the attack said he could hear sporadic gunfire nearly three hours after the attack began. "It is chaos out there. The streets are blocked. There are dozens of police commandos," said Tarique Mir.
Bangladesh has seen an increase in militant Islamist violence over the last year. Deadly attacks have been mounted against atheists and members of religious minorities in the mostly Muslim country of 160 million people, with attackers often using machetes.
Militants killed two foreigners last year, leading several Western firms involved in the country's $25 billion garment sector to temporarily halt visits to Dhaka.
Both Islamic State and al Qaeda have claimed responsibility for militant attacks in the country. But the government denies foreign militant organizations are involved and blames two local groups, Ansar-al-Islam and Jamaat-ul-Mujahideen.
The US State Department said all Americans working at the US mission there had been accounted for. A spokesman said in Washington the situation was "very fluid, very live."