Updated at 3pm

French police killed a gunman who killed at least two people while holed up in supermarket in southern France where he had taken hostages earlier on Friday, a source close to the investigation said.

"The hostage-taker is dead, the source said, adding that he was killed during a raid on the supermarket. Two officers were wounded, the source said.

The gunman is believed to have killed two people inside the supermarket and a third with bullet in the head in a nearby town before the hostage-taking.

He had claimed allegiance to the Islamic State group and demanded the release of Salah Abdeslam, the key surviving suspect of the November 2015 Paris attacks.

A witness reported that the assailant was armed with knives, a gun and grenades and shouted "Allahu Akbar" (God is greatest) before going into the the Super U store in the town of Trebes at around 11.15 am.

 "Most of the Super U staff and customers managed to get away," said a security source, who asked not to be named because he was not authorised to speak publicly.

A 45-year-old lieutenant-colonel swapped himself in exchange for one of the hostages, a source close to the investigation said later, confirming information first published by Le Figaro newspaper.

More than 240 people have been killed in France in attacks since 2015 by assailants who pledged allegiance to, or were inspired by, Islamic State.

Fifteen minutes before the supermarket incident in Trebes, a policeman was shot in the nearby town of Carcassonne while out jogging with several colleagues.

He was in a stable condition, Prime Minister Edouard Philippe said.

France still on high alert

Police traced the car involved in the shooting in Carcassonne to the hostage-taking in Trebes after it was found in the car park of the supermarket, a security source told AFP.

The shootings come with France still on high alert after a string of jihadist attacks since 2015.

Photo: AFP

The man "entered the Super U supermarket and shots were heard," a source told AFP on condition of anonymity.

Three helicopters could be seen circling over Trebes, a picturesque medieval town of around 5,000 people, while heavily armed police had closed down roads surrounding the supermarket.

The local prosecutors office were treating the incident as a terror attack and said the gunman had claimed to be acting in the name of IS.

"All the information we currently have leads us to believe it is a terrorist act," Philippe said while on a visit to Mulhouse in eastern France, cutting short the trip.

A police officer was also in hospital after being shot in a separate incident 15 minutes' drive away in the town of Carcassonne a quarter of an hour before the hostage-taking began.

Interior Minister Gerard Collomb was on his way to the scene.

The terror attacks in France started in January 2015 with the assault on satirical magazine Charlie Hebdo that left 12 people dead.

France also suffered major attacks in Paris in November 2015 when IS jihadists killed 130 people in bombings and shootings at bars, restaurants, the Bataclan concert venue and the national stadium.

In July 2016, in another attack claimed by IS, a man drove a truck through revellers celebrating Bastille Day in the Riviera resort of Nice, killing 84 people.

A state of emergency put in place just after the Paris attacks was finally lifted in October last year, but soldiers continue to patrol major tourist sites and transport hubs under an anti-terror mission.

If the link to Islamic State is confirmed, the hostage-taking would be the first deadly attack in France since October, when two young women were stabbed to death outside Marseille's main train station.

The area of southwest France where Friday's shootings took place has been scarred by Islamic extremism before.

In 2012, Mohamed Merah shot dead seven people including three Jewish schoolchildren in nearby Toulouse and Montauban.