Tensions in Indian-administered Kashmir hit a new level this morning when suspected Pakistan-backed militants took a family of six hostage after embarking on a killing spree in Jammu, the state's Hindu-dominated winter capital.

The incident looked set to stoke some of the worst violence in the troubled state since the outbreak of an all-out separatist insurgency in 1989.

The Muslim militants, whose hostages were said by the Indian Army to include two or three children, were holed up in a suburban house this morning, locked in a tense stand-off with Indian security forces. The two sides were shown trading fierce gunfire by local television stations.

The militants, who Indian security sources claim slipped over the border from Pakistan on Tuesday and were disguised as police, shot dead at least three people on the streets of Jammu, including an army officer, before taking the six hostages in a house on the outskirts of the city.

Brigadier P Murli, of the Indian Army, told The Times that there have been no negotiations between the militants and the security forces. It is understood that one militant has been killed and that two remain in the house with the hostages.

"We are working on establishing the layout of this very small house. We will wait it out and look for an opening," Brigadier Murli said.

Footage shown on Indian television of the killed militant being gunned down by security forces appeared to show the man holding his hands up as he stepped out of the two-storey house where the hostages are being held.

Brigadier P Murli denied that the man was trying to surrender. "It looks to me like he was trying to make a dash for it," he said. He added that the forces surrounding the building are operating under rules of engagement that allow them to "shoot-on-sight".

"The infiltrators in police uniform opened indiscriminate fire at several places before barging into a house near Chinore area," a police spokesmen said.

The allegation that the militants made their way from Pakistan will weigh on the already fraught relationship between India and Pakistan.

There has been a steady stream of small but violent incidents along the de facto border that splits the two nuclear-armed neighbours in recent weeks.

Indian security forces claim that there have been three significant incursions of the border between India and Pakistan since June.

The unrest has helped charge a resurgent separatist movement among Kashmir's Muslims – some of whom want outright independence and some of whom are calling for the India-controlled portion of the region to be handed to Pakistan.

On Monday, police killed five pro-separatist protesters who had defied a military curfew imposed in the Muslim-dominated Kashmir Valley, bringing the death toll over the past two months to at least 28.

Amid the ongoing violence, relations between Muslims and Hindus in the region have plummeted to historic lows.

The row between the two groups stems from the transfer of about 100 acres of land to the Hindu Amarnath shrine in June to build facilities for the hundreds of thousands of pilgrims that visit the site each year.

The move sparked fierce protests from Kashmir's Muslims and was rescinded by the state government. The u-turn prompted equally fierce retaliation from Hindu groups who set about blocking the only highway to the Kashmir Valley.

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