The incident took place in Aksu city when police intercepted a suspected vehicle on a tip off from residents. The suspects then attacked the police with knives and hurled burning devices at patrol cars.
One auxiliary police officer was seriously injured, state-run Xinhua news agency quoted local officials as saying.
"The police fought back and shot dead one suspect and captured another," the report said.
Police said one person with a knife who went on a rampage hacking at people was shot and captured.
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But eye witness accounts said three others were involved in the incident.
It was the third such assault in over two months with authorities blaming the first two on terrorists from China's Muslim-majority Xinjiang province in northwest.
China has blamed the al-Qaeda backed East Turkistan Islamic Movement (ETIM) for such attacks, which is fighting for the independence of Xinjiang.
On March 1, knife-wielding assailants killed 33 civilians and injured another 143 at a railway station in the southwestern city of Kunming.
The Urmuqi attack which was a combination of knife attack followed by bomb explosion was set off by two militants.
Xinjiang province bordering Pakistan-occupied Kashmir (POK) and Afghanistan has been restive for several years due to a conflict between native Muslim Uygurs and Han settlers from outside the province.