Officials are scrambling to trace the source of the infection, which so far has been found in 28 cases across the city's Northern Beaches region.
The New South Wales (NSW) government has urged all locals to wear a mask in public areas and to be on "high alert".
Local residents now face curbs on travel to Australia's other states.
The new cluster has sparked national concern and cast uncertainty over many Australians' plans for a relatively normal Christmas.
Prior to Wednesday, the country had recorded just one locally acquired case in the past fortnight.
What have Sydneysiders been told to do?
About 250,000 people live in Sydney's Northern Beaches - they have been asked to stay home until Monday and to get tested if they have symptoms.
Others have been told to avoid the area, and to use a mask when on public transport and in public spaces like supermarkets and churches.