Two assailants entered a local church, slitting the throat of an 84-year-old priest and leaving another hostage with life-threatening injuries, before being killed by police as they left the building, police said.
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The attackers were killed by the Search and Intervention Brigade, according to Pierre-Henry Brandet, Interior Ministry spokesman.
He added a bomb disposal team and sniffer dogs were searching the church and its surroundings for possible explosives.
The attack comes nearly two weeks since the Bastille Day massacre in Nice which left 84 people dead after Tunisian Mohamed Lahouaiej Bouhel drove a truck into a crowd celebrating the national holiday on 14 July.
The state of emergency was extended earlier this month after a man, who officials said radicalized quickly, drove a truck through a crowd during a Bastille Day celebration in Nice.
The Islamic State group claimed responsibility for the attack.
The claim came just hours after the attack in the Normandy town of Saint-Etienne-du-Rouvray.
French President Francois Hollande was on his way to the site of the attack. The two men were shot dead outside the church as police arrived.
Interior Ministry spokesman Brandet confirmed one of the hostages had been killed and said another was critical.
The French president traveled to the town.
The attack and a string of other deadly attacks a year ago claimed by the Islamic State group has put the French government under huge pressure to prevent further attacks.
Reports suggested that the priest died from a slashed throat during the incident, while one of the members of the congregation was seriously injured.
Prosecutors say they found documents about Al-Qaeda and IS at his home, and that he had been in touch with a suspected jihadist in Syria about an attack on a church. The detailed information and the motives of the attackers are still unknown.
Lombardi called the attack “more awful news, that adds to a series of violence in these days that have left us upset, creating vast pain and worry”.
Eulalie Garcia told the Daily Mail that she knew the priest personally and had taught her catechism as a young girl. However, authorities later discovered that the attack had been planned.
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A cell directed by Abaaoud later carried out the November 13 attacks in Paris that left 130 people dead and the March 22 attacks in Brussels that killed 32 people.
