Far right activists from the True Blue Crew, which says it is opposed to refugees and the 'Islamisation' of Australia, faced off with members of a left wing coalition promoting tolerance in the city.
Australia has seen a rise in far right activist groups and political parties opposed to Islam and Asian immigration following a number of 'lone wolf' attacks by home grown Islamist radicals.
Victoria Police said one person was arrested for possession of a weapon and one detained for breach of the peace, and a knife and a knuckle duster were confiscated.
"Police were forced to deploy capsicum spray when a small number of protestors attempted to breach a police line, with one person given aftercare as a result of the capsicum spray," a spokeswoman said.
TV footage showed nationalist protesters holding Australian flags on poles or draped around their shoulders, while opposition protesters held placards with anti racism messages.
The rally attracted hundreds of protesters and a heavy police presence kept the opposing groups separated, local media reported.
Australia, a staunch ally of the US, has been on high alert for home grown Islamist attacks since 2014 and authorities say they have thwarted a number of plots.
Far right groups and political parties like Pauline Hanson's One Nation have seized on the mood to push anti immigration agendas.
Concern about immigration has also seeped into the mainstream political discourse, with the governing Liberal National coalition vowing to tighten rules around citizenship and require applicants to demonstrate how they have embraced 'Australian values'.
Phillip Galea, a fixture at rallies organised by the True Blue Crew, was charged with planning a terror attack in August last year.
It was the first time federal terrorism laws had been used to target such right wing groups.
(This story has not been edited by NDTV staff and is auto-generated from a syndicated feed.)