Peruvian forces have begun an operation to re-take a police station from a group of 150 renegade army reservists in a remote town in the southern Andes.
The rebels have been allowing reporters behind their defences
Troops and police darted about the streets as shots rang out near the building in Andahuaylas, where the ex-soldiers are holding 10 hostages.
One rebel was apparently shot dead and at least one other wounded.
Antauro Humala, a former major leading the rebels, has been calling for President Alejandro Toledo to quit.
Photographs taken inside the rebels' positions show one man lying covered in blood, surrounded by rebel soldiers and a second man being led away with a head wound.
Four police officers were killed and 19 wounded when Maj Humala's group seized the station on Saturday.
The Peruvian interior ministry said an "intervention to retake the police station" had begun at about 1400 (1900 GMT).
Humala's group looks to Peru's Inca past for inspiration
Live TV pictures showed heavily armed police and troops in small groups hugging walls as they moved through the town while gunfire crackled in the background.
About 1,000 members of the Peruvian security forces have massed in the town, 275 miles (440km) from the capital, Lima. The government has declared a state of emergency in the surrounding Apurimac region.
The rebels are former members of the military or national police, who include veterans of conflicts with Ecuador and Peru's own leftist rebels.
Maj Humala earlier agreed to lay down arms in return for a guarantee of safety for his men but he later retracted his offer, accusing the government forces of firing at them.
President Alejandro Toledo's popularity has been falling in Peru
He had been calling for a special commission to travel to Andahuaylas from Lima to negotiate an end to the crisis.
The group accuses the president, who has become deeply unpopular, of betraying Peruvian interests to the country's neighbour, and rival, Chile.
Maj Humala described his followers as veterans of nationalist wars and "symbols of the Peruvian youth, treated as bastards in their own land".
On Sunday, he said his brother, Lt Col Ollanta Humala, who is reported to be in South Korea, had ordered the group to put down their weapons.
However, the interior ministry also issued a statement asking people living near the police station to vacate their homes - sparking rumours of an impending assault.
In October 2000, Maj Humala and his brother led 50 followers in a short-lived military uprising, just a month before the government of President Alberto Fujimori collapsed.
The BBC's Elliott Gotkine reports that the rebels accuse the unpopular leader of corruption and of selling out to business interests in Chile, which is Peru's historic rival.
But the group's broader aim, he adds, is to establish a nationalist indigenous movement modelled on the ancient Inca Empire.