The four-time world champion got the jump on the Mercedes ace off a miscalculation on the pit stop under Virtual Safety Car conditions and held off Hamilton for his second straight win in Melbourne and third overall.
“Nice one, nice one altogether,” Vettel said jubilantly over team radio.
“We’re getting there. We still have some work to do, but we’re getting there.”
It was Vettel’s 48th win in his 200th GP and follows his earlier wins in Melbourne in 2011 for Red Bull and last year for Ferrari.
Hamilton, starting off the pole, got out his car and looked a bit bewildered as he removed his helmet, wondering how exactly that race got away from him.
Vettel pitted for a new set of softs and emerged from the pits ahead of Hamilton, gaining around 10 seconds thanks to the deployment of the Virtual Safety Car (VSC).
“What just happened guys? Was that my mistake?” Hamilton said on team radio as a full-on safety car was sent out as the marshals struggled to remove the stranded Haas car of Romain Grosjean.
“We thought we were safe, but there’s obviously something wrong,” the team told Hamilton.
Mercedes potentially miscalculated the VSC minimum speed during the phase Vettel claimed the lead.
Vettel retained his lead as the race was restarted and built a lead of seven-tenths of a second over Hamilton mid-race.
Hamilton made an error as he locked up at turn nine and fell 2.8 seconds behind Vettel with 11 laps remaining.
Vettel proved too resilient and held on as Hamilton backed off over the final laps realising he could not catch the flying German.
“Well done guys, very proud of you. Long winter, long seasons in the past but now we can fight, we can fight,” Alonso said over the team radio.
Valtteri Bottas has been dealt a further blow following confirmation that he will be forced to serve a grid penalty following his qualifying crash.
Bottas lost control of his Mercedes on the exit of turn two at Melbourne’s Albert Park and suffered significant damage to his car after he smashed into the wall.
The 28-year-old Finn emerged unscathed from the 110mph shunt, but will drop five places on the grid after his Mercedes team revealed he will require a new gearbox.
It means Bottas is due to start a lowly 15th at Sunday’s season-opening Australian Grand Prix.
In contrast, Bottas’ team-mate Lewis Hamilton will line up from pole position after he stormed to the top of the order following his emphatic qualifying lap.
“It is a garage of contrasting emotions today with a really unfortunate end to qualifying for Valtteri,” Toto Wolff, the Mercedes executive director said.
“It was a big hit and the boys will have a long job list to get the car ready to race. It’s now about putting the incident behind him and recovering as strongly as possible.”
Bottas was taken to the medical centre for a precautionary check-up following the high-speed crash before he was swiftly given the all-clear.
The former Williams driver is out of contract with Mercedes at the end of the season, and his crash here is hardly the start he needed in his pursuit of a new deal.
“I went wide in turn one and the kerb was still a bit damp, so I lost the rear of the car and hit the wall outside of turn two,” Bottas explained.
“It’s very unfortunate and I feel sorry for the team because we have a really competitive car. It looked like it was damaged pretty badly, so I really hope we can fix it for the race.
“Overtaking is difficult on this track, but we’ll try everything we can. We have a good car, so I’ll try to fight back.”
Hamilton was in a class of one as he steered his Mercedes to the front slot of the grid with an utterly emphatic display which will send out an all-to-familiar warning to his rivals.
The 33-year-old British driver’s best lap was more than an eye-watering six tenths of a second faster than the rest of the field with Kimi Raikkonen edging out his Ferrari team-mate Sebastian Vettel for second.
Red Bull’s Max Verstappen qualified fourth ahead of his team-mate Daniel Ricciardo, who is due to serve a three-place grid drop following an infringement in practice on Friday.
But it was not a perfect session for Hamilton’s Mercedes team after Valtteri Bottas crashed into the wall and out of qualifying at the exit of turn two.
Bottas emerged unscathed from the 110mph smash, which happened on his very first lap in the battle for pole, but the same could not be said of his car.
The rear of his Mercedes, which bore the brunt of the high-speed impact was destroyed with bits of his car littering the asphalt. Bottas was taken to the medical centre for a precautionary check-up before he was swiftly given the all-clear.
The session was suspended to deal with the swathes of Mercedes debris on the track, but following a 10-minute delay, the top-10 shootout resumed and it was Hamilton who blitzed the pack with a lap he described as close to perfection.
“You would think that with these results we have had it would start to feel like the norm, but it doesn’t,” said an ecstatic Hamilton after securing his seventh pole in Melbourne.
“My heart is racing. I am so happy with that lap. It was such a nice lap. I am always striving for perfection and that was as close as I could get.”
McLaren arrived here in Melbourne on the back foot after a thoroughly underwhelming pre-season campaign which was blighted by reliability issues.
They ran into further trouble here on Friday after their star driver Fernando Alonso and his team-mate Stoffel Vandoorne suffered exhaust leaks.
Both men managed to get through qualifying in one piece, but they fell at the second phase with Alonso due to start 11th and Vandoorne 12th.
The McLaren hierarchy had targeted a battle with Red Bull this season following their divorce from Honda engines and switch to Renault power.
But Alonso was more than one second adrift of the Red Bull cars, proving there is plenty of work to be done by the Woking marque. Indeed, Alonso qualified 13th in Melbourne last year, and 12th in 2016.
“That is okay,” said Alonso, when informed of his grid position, but you fancy both the Spaniard and his team will have harboured greater expectations heading into the opening race.
Kevin Magnussen and Romain Grosjean qualified an impressive sixth and seventh for Haas ahead of the Renault duo of Nico Hulkenberg and Carlos Sainz.