A local policeman told a French radio station that he saw the plane dive abruptly and plunge into the sea.
"I could see it was an airliner because I saw two large engines. There was no fire, nothing," the witness told France Info radio.
"It was flying straight, then it turned brutally towards the ground. I said to myself it will never pull out and there was a big spray of water."
There were five New Zealanders and two Germans on board the aircraft which had been leased to German carrier XL Airways and was being tested after a refit prior to return to New Zealand next month, an airline official said.
The Pyrenees-Orientales prefecture, the regional authority, said the plane was on a "technical flight" and was being serviced by a company based in Perpignan.
Diving teams and a helicopter were on site and a navy vessel had been dispatched to search for the aircraft's flight recorder.
Two bodies were recovered but conditions were difficult with bad weather and darkness.
"I'm hopeful there still may be survivors ... and I certainly haven't given up hope"
Rob Fyfe, CEO of New Zealand Air
Airbus, in a statement, promised to assist air crash investigators and has sent five specialists to the site but added that it would be inappropriate to speculate on the causes in the absence of "factual information".
Speaking in Auckland, Rob Fyfe, the chief executive of Air New Zealand, said he was not prepared to assume that all seven on board the A320 had been killed.
"I'm hopeful there still may be survivors, early indications are that the plane and debris were floating on the water, and I certainly haven't given up hope," he told a news conference.
Fyfe said the incident, which comes exactly 29 years to the day of New Zealand's worst-ever air crash when the airline's plane on a sightseeing trip in Antarctica hit the side of Mount Erebus, killing all 257 people on board "just adds to the sense of tragedy".