Police in Australia arrested seven suspects who were allegedly planning a series of Christmas Day bomb attacks in the heart of the country's second largest city.

The suspects had been inspired by the Islamic State group and planned attacks on Melbourne's Flinders Street railway station, neighbouring Federation Square and St Paul's Cathedral, Victoria state Police Chief Commissioner Graham Ashton said.

The arrests came after a truck smashed into a Christmas market in Berlin on Monday, killing 12 people.

Two of seven people initially arrested in raids on Thursday night and Friday morning in Melbourne - a 26-year-old man and a 20-year-old woman - were released without being charged.

Five men between ages 21 and 26 remained in custody. They were not identified but police said four were born in Australia and the fifth was Egyptian-born with Egyptian and Australian citizenship.

Police had been watching the alleged plotters for some time, and believed they were preparing to use explosives and other weapons, Mr Ashton said.

The authorities believed the threat to Melbourne had been neutralised by the raids and the arrests, he said.

Mr Ashton said police had gathered evidence in the raids that the plotters were planning to use explosives in their attack.

"We gathered the makings of an improvised explosive device," he said.

He added: "Certainly (there was the) potential for quite a number of people to be injured or killed in this attack."

About 400 police officers were involved in the raids.

Mr Ashton described those arrested as "self-radicalised" and inspired by Islamic State propaganda.

Victoria state Premier Daniel Andrews said there will be extra police on the streets of Melbourne on Christmas Day to make the public feel safe.

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