Gunmen stormed a restaurant popular with expatriates in the diplomatic quarter of the Bangladeshi capital of Dhaka on Friday night and took around 20 people hostage, including several foreigners, in an attack claimed by Islamic State.

Security officials said two police officers had been killed, but denied a report by Islamic State that 24 people were dead in the assault.

Italian and Indian nationals are among the hostages, said a duty officer at the Rapid Action Battalion's (RAB) control room, adding that gun battles had stopped.

The hostage crisis, which continued into early hours of Saturday, marks an escalation from a recent spate of murders claimed by Islamic State and al Qaeda on liberals, gays, foreigners and religious minorities, and could deal a major blow to the country's vital $25 billion garment sector.

Last year, several Western retailers temporarily halted visits to Dhaka following the killing of two foreigners.

Police said eight to nine gunmen attacked the Holey Artisan restaurant in the upscale Gulshan area of Dhaka.

A SPIKE IN MILITANT ATTACKS

The assailants, believed to be carrying assault rifles and grenades, exchanged sporadic gun fire with police outside for several hours after the attack began around 9 p.m. local time.

At least 15 people were injured, police said. RAB official Khalid Ibn-Hossain said police were trying to speak with the gunmen but had not been able to.

"We are discussing ways to rescue the people, including foreigners, who are inside the cafe," police official Mohammad Habibur Rahman said. "Our priority is to rescue them peacefully without the loss of any life."

Bangladesh has seen a spike in militant violence in the last 18 months. Attacks have tended to be on individuals, often using machetes, and the raid on the restaurant was a rare instance of a more coordinated operation.

Earlier on Friday, a Hindu priest was hacked to death at a temple in Jhinaidah district, 300 kms (188 miles) south west of Dhaka.

Both Islamic State and al Qaeda have claimed responsibility for many of the killings, although local authorities say there are no operational links between Bangladeshi militants and international jihadi networks.

Bangladesh security officials say two local militant groups, Ansar-al-Islam and Jamaat-ul-Mujahideen, are behind the violence. Ansar pledges allegiance to al Qaeda, while Jamaat-ul-Mujahideen claims it represents Islamic State.

"The bottom line is Bangladesh has plenty of local, (often unaffiliated), militants and radicals happy to stage attacks in ISIS's name," said Michael Kugelman, South Asia associate at The Wilson Centre in Washington D.C., using an acronym commonly used for Islamic State.

He added that Islamic State had claimed more attacks in Bangladesh than in Pakistan or Afghanistan.

SPORADIC GUNFIRE, CHAOS

Benjir Ahmed, chief of Bangladesh's special police force, said police were preparing to launch an operation to rescue those being held captive. Ahmed said the attackers had hurled bombs at police.

A police officer at the scene said that when security forces tried to enter the premises at the beginning of the siege they met a hail of bullets and grenades.

Television footage showed a number of police being led away from the site with blood on their faces and clothes. Heavily armed officers could be seen milling on the street outside.

A resident near the scene of the attack told Reuters 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.

Italy's Foreign Minister Paolo Gentiloni said on Twitter he was closely following the situation in Dhaka, adding he was "anxious for Italians involved" and expressing solidarity with their families.

Prime Minister Matteo Renzi abruptly left a ceremony at the Colosseum in Rome on Friday evening to follow the hostage-taking incident, a source at his office said.

The U.S. State Department said all Americans working at the U.S. mission there had been accounted for. A spokesman said in Washington the situation was "very fluid, very live".

President Barack Obama has also been briefed about the attack, the White House said. – Reuters