A resident that spoke to Reuters via telephone with the crackle of gunfire in the background said, "Fighting broke out (in Lalibela) an hour ago and I am now hiding in my home."
The resident was supported by a deacon at one of Lalibela's 11 churches, which date back to the 12th and 13th centuries and are a major attraction for Coptic Christians and tourists alike.
Fighting started around 8 a.m "in all parts of the city," the deacon said. "They are using all kinds of weapons. I could feel the vibrations."
The deacon said a metal shelter built to protect one of the churches had been hit three times by stray gunfire.
Government spokesperson Legesse Tulu disputed the reports of violence, saying that the city and its surroundings were peaceful.
The army has been battling Fano, a part-time militia in the northern Amhara region which has no formal command structure, since late July.
The part-time militia captured Lalibela, and Gondar, the second-biggest city in Amhara, for several days in August before being repulsed.
The fighting, which has killed hundreds of people, is the biggest security challenge faced by Prime Minister Abiy Ahmed since the Tigray war ended a year ago.
Fano fighters backed Ethiopian troops during the two-year civil war in Tigray, but relationships soured over disputed land in western and southern Tigray, and after the government said it would integrate regional forces into the police and federal army.
Designated a UNESCO World Heritage site in 1978, Lalibela's cave churches were carved out of monolithic blocks to form a "New Jerusalem" after Muslim conquests halted Christian pilgrimages to the Holy Land.
The federal army and Amhara's regional administration did not immediately respond to requests for comment.