Police said a man was decapitated during the incident at a gas factory near Lyon earlier this morning.
Two attackers set off an explosion at the building in Saint-Quentin-Fallavier before showing flags and banners with Arabic writing on.
Several other people are reported to have been injured.
A 35-year-old father of three has been arrested and is thought to have been known to security services.
Tim Evans, reader at Lyon Anglican Church, about 20 minutes from the scene, told Premier it was a "shock".
"Whenever something like this happens, you're not really expecting it," he said.
He added that security was already very tight in Lyon but that he expected it to be reinforced very quickly.
But he said "there are just so many churches that it's impossible to protect them all".
France has been on high alert since an attack in January when brothers Said and Cherif Kouachi killed 12 people at satirical magazine Charlie Hebdo in Paris.
In April three people were arrested by police investigating a plot to carry out terror attacks at churches.
Speaking in Brussels, President Hollande said he had "no doubt" it was a terrorist action.
He added: "The attack has all the hallmarks of a terrorist attack.
"A decapitated body was found with inscription written on it.
"There is one dead and two injured.
"The suspect was arrested and identified."
A spokeswoman for the Prime Minister said authorities were "looking at the situation closely" but she refused to say if security was being stepped up in the UK.
This article is being constantly updated.