Police have surrounded the house of a 24-year-old man suspected of killing seven people including three children.
The suspected gunman is a Frenchman from Toulouse with Algerian origins who said he was a member of al-Qaida, interior minister Claude Gueant said.
Police are negotiating with the man who still refuses to surrender following the raid in the Croix-Daurade district of Toulouse.
The suspect has been named as name Mohammed Merah, the AFP news agency has reported, citing a source close to the investigation.
According to the director of Kandahar prison in Afghanistan, Merah escaped from the jail in a 2008 breakout.
At his besieged home he is believed to be armed with a Kalshnikov, an Uzi and a number of handguns. Negotiations with police are said to have stalled.
He said he had acted "in revenge for Palestinian children" and French military operations abroad and called himself a Mujahedeen - a holy warrior.
Two police officers were injured during the raid after the man shot at the door when they arrived. One officer was shot in the knee and the other in the shoulder.
Reports have surfaced that following failed initial negotiations police are preparing for a second raid.
Gueant said the police want the suspect alive.
Authorities say they are confident the man is responsible for the attacks that killed three military men last week and three children and a rabbi at a Jewish school in Toulouse on 19 March.
The man's mother, who is Algerian, is at the scene but refused to become involved in the negotiations.
One of the man's brother has been arrested and a second brother has attended a police station, French media said.
An official told Agence France-Presse that the suspect had been "in the sights" of France's intelligence agency after the first two attacks, after which police had brought in more "crucial evidence".
French media say the man is said to belong to a group called Forsane Alizza (Knights of Pride), which was banned by Gueant last month.
Reports also suggest the man had previously been arrested in Kandahar, Afghanistan, though not for a terrorist act.
Police traced him because of an e-mail he sent to his first victim about buying a scooter.
He reportedly sent an e-mail to the victim from his brother's account, set up an appointment and once there killed the soldiers, sources said.
The man also tried to have his scooter, which he used in all three attacks, repainted after the first two crimes.
Gueant said the man intended to hand himself over this afternoon.
The man also allegedly called France 24 newsroom and told them he would post videos of his killings online.