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.

The clashes also came on the same day as a repatriation agreement was signed between Myanmar and Bangladesh to start the return of some 655,000 Muslim Rohingya refugees from squalid camps back over the border.

The ethnic Rakhine revile the Rohingya, who they decry as illegal "Bengali" immigrants to a Buddhist land.

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.

"Seven people were killed and 13 injured," he said adding more than 20 police were wounded by the crowd, who were calling for the "sovereignty of Rakhine state".

"The situation is under control now. Security is being deployed in the town at this moment," the police spokesman said.

A hospital in the nearby state capital of Sittwe said it was treating six of the wounded who arrived early Wednesday.

"Five of them had gunshot wounds while another looked to have been beaten," Dr Khing Maung Than, of Sittwe hospital told AFP.

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.

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.

"I think there will be a risk for spillover into intercommunal violence," independent analyst Gabrielle Aron said.

"The degree of risk will depend partly on how well or poorly security forces are seen to respond to the events of last night," she said, adding the situation "could deteriorate".