The incident unfurled as around 5,000 Buddhists gathered late Tuesday for a nationalist ceremony in Mrauk U, a town that has so far remained unscathed by the military's crackdown on the region's minority Rohingya Muslim community.
It was not immediately clear why the rally descended into violence.
But ethnic Rakhine, many of whom are poor and marginalised, have a long-standing enmity with the Myanmar state which is dominated by ethnic Bamar.
Rakhine say the Rohingya are illegal "Bengali" immigrants to a Buddhist land.
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A police spokesman blamed the crowd for "starting the violence" by throwing stones and barging into a district administrative office and hoisting the Rakhine State flag.
"Security forces asked them to disperse and fired warning shots with rubber bullets... but they didn't stop, so police had to use real bullets," spokesman Colonel Myo Soe told AFP.
Photographs showed bodies laid out on the floor of a makeshift mortuary in Mrauk U on Wednesday, the clothes of the victims stained with blood.
The shootings further raise the temperature in an already combustible area of Myanmar.
"It's not forgivable that they used guns," Mrauk U lawmaker Oo Hla Saw of the Arakan National Party said, confirming the death toll and labelling the police action "a crime".
Witness Nyi Nyi Khant, 29, said the clashes could have been prevented if the police had intervened earlier.
Mrauk U, home to an ancient Buddhist complex of the last Rakhine kingdom, lies a few dozen kilometres from the epicentre of violence that saw Rohingya driven in their hundreds of thousands into Bangladesh since last August.
The military led a brutal crackdown against the Rohingya after militant attacks against border posts killed around a dozen police.
Rohingya say security forces, backed by hardline Rakhine mobs, torched hundreds of Rohingya villages and forced them to flee.
Already shredded by communal hatreds, Rakhine state also has a Buddhist rebel group called the Arakan Army which is fighting Myanmar's army.
The clashes garner little attention in a state dominated by violence against the Rohingya and in a country where several larger ethnic insurgencies are burning.
Observers warned Tuesday's violence could open a new chapter of unrest in the febrile state.
The United Nations said it "deplored" the loss of life and urged an investigation into "any disproportionate use of force".
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