The territory is on the coast of Morocco where hundreds of migrants are being placed.
In a letter to Madrid, the Council of Europe said some 500 people are in lockdown in the Melilla bullring.
The migrants have limited access to showers and toilets, and not enough food and water.
In addition, "no identification of vulnerable persons or medical screening is reportedly taking place," the council's human rights commissioner Dunja Mijatovic wrote.
Every year thousands of migrants try to enter Melilla as well as Ceuta, Spain's other foothold in Morocco, since arrival would give them a chance at EU asylum.
Registered asylum seekers in the territories are also allowed to move freely within Spain, and the council urged Madrid to transfer more migrants to the mainland.
But while acknowledging the challenges for the Spanish government in housing the migrants while containing the Covid-19 outbreak, "the situation prevailing in the 'plaza de toros' does not appear to be adequate from a human rights point of view," Mijatovic said.