The 140-year-old GlĂłria funicular, which is popular with tourists, derailed and crashed into a building near Liberty Avenue at around 18:15 local time (17:15 GMT) on Wednesday.
Foreign nationals are among those killed, authorities said, although the identities of the victims have not been confirmed. Some of the injured are in a serious condition.
Lisbon's Mayor Carlos Moedas called it a "tragic day for our city" while Prime Minister LuĂs Montenegro said it was "one of the biggest human tragedies of our recent history".
Footage shared on social media showed the crumpled yellow funicular overturned in the cobblestone street and people running from the area as smoke filled the air.
Several passengers trapped in the wreckage had to be freed by emergency responders, authorities said.Lisbon officials had initially put the death toll at 17, however the number was revised to 16 by the prime minister during a news conference on Thursday.
A further five people are in a critical condition in hospital, Montenegro said.
Officials have not confirmed what caused the crash, but eyewitness reports suggested that the braking system on the cable-hauled funicular failed, sending it hurtling down the steep street and into a building
A witness told Portuguese TV channel SIC that the funicular, which can carry around 40 people, "hit a building with brutal force and collapsed like a cardboard box; it had no brakes".
It is not known how many passengers were on board when the crash happened.
Portuguese newspaper Observador reported that a cable came loose along the railway's route, causing it to lose control and collide with a nearby building.
One witness told Observador that the vehicle was "out of control, without brakes".
"We all started running away because we thought [the carriage] was going to hit the one below," said Teresa d'AvĂł."But it fell around the bend and crashed into a building."
An investigation has now been launched by Lisbon prosecutors, police and the transport accident investigation department.
The city's public transport operator, Carris, said it had complied with "all maintenance protocols". Interim maintenance was carried out last year and regular monthly and weekly checks had been done, it said.
The company is "very sorry about what happened" and has opened its own investigation.
Lisbon's three other lines have been suspended while inspections are carried out, authorities said.
European Commission President Ursula von der Leyen sent her condolences to the families of the victims, while Portugal's President Marcelo Rebelo de Sousa and Spain's Prime Minister Pedro Sánchez also sent their sympathy.Sánchez said he was "appalled by the terrible accident".
