Police said they belonged to a Bangladeshi group blamed for an attack on a Dhaka cafe earlier this month in which 20 hostages, mostly foreigners, were killed and had been planning another large-scale assault.
"Nine militants were killed after two hour-long gunfight" deputy commissioner of Dhaka Metropolitan Police (DMP) Masud Ahmed told AFP, adding another extremist was shot and arrested during the raid in Kalyanpur neighbourhood.
National police chief AKM Shohidul Haque told reporters they suspected all 10 were members of the homegrown extremist group Jamayetul Mujahideen Bangladesh (JMB), which was blamed for the Dhaka cafe attack.
Five gunmen stormed the Holey Artisan Bakery in the upscale Gulshan neighbourhood on July 1 and killed 20 hostages including nine Italians and seven Japanese nationals before commandos ended the siege.
Islamic State (IS) group claimed responsibility for the attack and posted gruesome images of the carnage before the military stormed the cafe.
Bangladeshi authorities have rejected the claim, saying international militant networks have no presence in the world's third largest Muslim majority nation.
Haque stressed that the nine killed in Tuesday's operation had no connection with Islamic State 'jihadists' even though they were wearing the group's signature black robes.
"We think they are all JMB members... We have not found any link with IS. They are all local Bangladeshi militants," he said.
Haque added that they had rented a fouth-floor flat and were planning to launch a large-scale attack.
"From police intelligence sources we learnt that they were planning to carry out a major incident. We conducted the operation to foil any such incident," he said.
Police said they cordoned off an apartment building after suspects threw a small hand bomb at officers who were conducting a "block raid" in the area after midnight.
The gunmen exchanged fire intermittently throughout the night and shouted "Allahu Akbar" ("God is the Greatest") as the neighbourhood was sealed off by hundreds of heavily armed police and the elite security force Rapid Action Battalion, police said.
"This morning police launched Operation Storm 26 and was able to destroy the militants. We're now sweeping the place," Dhaka additional police commissioner Sheikh Maruf Hasan who led the raid told AFP.
"Their dress and their slogans before and after the attack all proved that they are members of (extremist) militant force," Hasan said, adding that they were wearing black tunics and shouting "Allahu Akbar".
Bangladesh is reeling from a wave of deadly attacks by Islamist extremists.
The government and police say homegrown extremists are responsible for the deaths of some 80 secular activists, foreigners and religious minorities since 2013.
Both IS and a branch of al Qaeda have claimed responsibility for many of the attacks.
After the cafe siege, suspected extremist militants also launched a gun attack at the country's largest Eid prayer rally where some 250,000 people were marking the end of Ramazan.
At least three people and a gunman were killed in the attack.
The government of Prime Minister Sheikh Hasina has since launched a nationwide man-hunt for militants, arresting more than a dozen suspected extremists including one of JMB's regional heads.
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