Australian police Wednesday said an "imminent" terror attack has been foiled in Sydney with two men arrested and a machete, a hunting knife, a video, and an Islamic State flag seized.

New South Wales Deputy Police Commissioner Catherine Burn said it would be alleged that the attack being planned was "consistent with the messaging coming out of IS".

Asked whether the planned attack was a beheading, Burn said police were as yet unsure of its nature but that it was imminent and likely to have involved a knife.

"We believe that the men were potentially going to harm somebody, maybe even kill somebody, and potentially using one of the items that we identified and recovered yesterday, potentially a knife," she said.

The men were arrested in a raid on a property in Sydney's western suburbs on Tuesday and have been charged with undertaking acts in preparation or planning for a terrorist act.

"A number of items were located including a machete, a hunting knife, a home-made flag representing the prescribed terrorist organisation IS, and also a video which depicted a man talking about carrying out an attack," said Burn.

"We will allege that both of these men were preparing to do this act yesterday. We built up information, we received further information which indicated an attack was imminent. And we acted."

Australia in September raised its terror threat level, and carried out extensive raids in Sydney and Brisbane to disrupt an alleged plot by IS supporters to abduct and behead a member of the public.

The Islamic State group is a brutal jihadist organisation that has captured swathes of territory across Iraq and Syria and sucked in increasing numbers of radicalised Australians to its cause.

In December, Sydney was rocked by a siege at cafe by Iranian-born Man Haron Monis, a self-styled cleric with a history of extremist views.

He took 17 people hostage for some 16 hours, with the siege ending after Monis shot dead cafe manager Tori Johnson, prompting police to storm the building and kill him. Another hostage died in the crossfire.

Prime Minister Tony Abbott on Monday reiterated that the cafe siege was inspired by the Islamic State "death cult".

Burn said she did not know the exact nature of the target in this week's alleged attack but that one of those arrested featured in the video seized.

"We can't go into the details of what was actually said in that message," she said. "However, the intent is clear and the intent is what I have told you today."