A man once flagged for ties to Islamic radicals has rammed a vehicle into a gas factory in France, triggering an explosion that injured two people before the severed head of his employer was found hanging at the factory entrance.

Officials immediately opened a terrorism investigation as prime minister Manuel Valls said: "Islamist terrorism has again struck France."

The attack began when the vehicle made it through the gate of the US-owned factory in Saint-Quentin-Fallavier, south-east of Lyon.

The vehicle then ploughed into gas canisters, touching off the blast, president Francois Hollande said in Brussels, where he was attending a European Union summit.

"No doubt about the intention - to cause an explosion," Mr Hollande said, calling the attack "of a terrorist nature".

The French president later raised the security alert for the south-eastern region to its highest level for the next three days.

No group immediately claimed the attack, but the severed head appeared to mimic the Islamic State group's practice of beheading prisoners and displaying their heads for all to see. The man's body was found elsewhere on the grounds.

A security official said two flags - one white and one black, both bearing Arabic inscriptions - were found nearby.

Interior minister Bernard Cazeneuve said the main suspect - a man from the Lyon region who had been flagged in 2006 for suspected ties to radical Salafists - was seized by an alert firefighter. Mr Cazeneuve said the suspect had been known to intelligence services, who had him under surveillance from 2006 to 2008.

A police official said the man in custody, Yassine Salhi, is in his 30s and a resident of the Lyon suburb of Saint-Priest.

Officials said the decapitated man ran a local transportation company that employed Salhi. One official said he was believed to have been killed before the attack on the factory and was not killed by the explosion.

Three other people, including Salhi's wife, were taken into in custody.

Paris Prosecutor Francois Molins said Salhi was known to factory personnel because he came in regularly for deliveries. The attacker entered the factory grounds in a utility truck, then crashed the vehicle into a hangar at the site, prompting an explosion.

Mr Molins said the attacker, his wife, sister and another suspect are in custody. He said investigators are trying to determine whether there are accomplices.

The gas factory belongs to Air Products, a US chemical company based in Pennsylvania. The company said all its employees had been accounted for and were evacuated from the premises but did not say if any had been injured.

"The site is secure. Our crisis and emergency response teams have been activated and are working closely with all relevant authorities," the company said in a statement.

Air Products makes gases used by a wide range of industries, including food production, medicine and oil and gas. It has more than 20,000 employees in 50 countries, mostly in the Americas, Europe and Asia.

One official said the suspect apparently miscalculated how explosive the chemicals he smashed into would be, but Mr Hollande said a major explosion appeared to be the goal.

France went on high alert in January after attacks against the satirical newspaper Charlie Hebdo, a kosher grocery store and a policewoman that left 20 people dead in the Paris region, including three Islamic extremist attackers.

Since then, fears of copycat attacks have risen. One person was arrested in April after authorities said he was plotting to gun down people in churches in the Paris region.

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