According to witnesses, they opened fire on an air force jet circling their forces and dropping bombs, witnesses said.
Residents fled or tried to hide as the attackers charged into Damaturu firing their guns and shouting "Allahu Akbar" (God is greatest), people at the scene told Reuters.
Yobe is at the heart of a five-year insurgency by Boko Haram militants, fighting to carve an Islamist state out of Africa's top oil producer.
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The gunmen arrived at 5.30 am and attacked a police station, said witnesses. Local Bala Aminu said he later saw the city's university campus and a nearby police base in flames.
"I saw a military jet circling three times. People have abandoned their vehicles on the road and gone home," resident Mustapha Usman said by phone.
Another resident, hiding behind a gate, said he saw the militants driving down a road in police vehicles and an armoured tank, trying to shoot down the plane.
"They mounted anti-aircraft guns and they are trying to shoot the aircraft that was bombarding the town. They were all turning their heads shooting and moving towards Gujba road (south east of the city)," he added.
The gunmen launched their attack from the nearby town of Buni Yadi, a Boko Haram stronghold, said residents. No one was immediately available for comment from the ministry of defence.
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Boko Haram, which has killed thousands and kidnapped hundreds in gun attacks, was blamed for a coordinated bomb and gun attack on the central mosque in the country's second biggest city, Kano on Friday.
President Goodluck Jonathan has asked the national assembly to extend the state of emergency, which expired on 20 November, but no decision has yet been reached.