Rt Revd Robert Forsyth has ordered all his churches to open their doors to let people pray as negotiations continue with a gunman inside the Lindt Chocolat Cafe in Martin Place.
He said: "We're a rich and prosperous city in which the only concern until this morning was, have I got the right present for Christmas?"
The bishop told Premier that despite the terror threat level being at severe he was still surprised and found it 'hard to believe'.
"It's a place I know very well, it's near one of our churches," he said.
"It's the shock of the unfamiliar, the violence in the midst of something you know so well, I think that's the shock."
The gun man is wearing an Islamic head scarf and made hostages hold a flag against the cafe window which appeared similar to that used by Islamic State militants in Iraq and Syria.
The bishop said it would be hard to stop this attack causing a deterioration between Christians and Muslims in Australia.
"Unofficially this will lead to a deep resentment," he said.
"Officially I think we'll try very hard as we'd have to, to maintain order, because you don't want to play into the man himself.
"Why is he doing this? To increase radicalism and to make the narrative of Islamic victimhood stronger."
Bishop of South Sydney Rt Rev Robert Forsyth speaking to Premier's Aaron James: