Australia police said on Wednesday it has foiled "imminent" terror attack, arresting two men and seizing an ISIL flag, a machete and a video detailing the plot during a raid in Sydney.

Australia police said on Wednesday it has foiled "imminent" terror attack, arresting two men and seizing an ISIL flag, a machete and a video detailing the plot during a raid in Sydney.

Catherine Burn, New South Wales Deputy Police Commissioner, said planned attack seemed "consistent with the messaging coming" from the Takfiri group ISIL.

Asked whether it involved a beheading, she said police were as yet unsure but that it was planned for Tuesday in Sydney and would likely 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, aged 24 and 25, were arrested in a raid on a property in Sydney's western suburbs on Tuesday and have been charged with undertaking acts in preparation for a terrorist act.

"A number of items were located including a machete, a hunting knife, a home-made flag representing the proscribed terrorist organization ISIL, 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."

Mike Baird, New South Wales state premier, said a potential "catastrophic" incident had been avoided.

"It was beyond disturbing, what was planned," he said. "Certainly, something catastrophic was avoided yesterday and for that we should be very thankful."

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

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

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