Mursi packed off Tantawi as well as the number two in command General Sami Anan into "retirement" and appointed both of them as 'advisers' to the president.
Field Marshall Abdel Fattah Al-Sisi was appointed minister of defence and general commander of the Egyptian forces replacing Tantawi, presidential spokesperson Yasser Ali announced in a televised statement.
The radical development came as a surprise and no reason was given immediately for the move.
In another move that signifies an aggressive approach, the President also annulled an addendum to the constitutional declaration that was issued by the Supreme Council of the Armed Forces (SCAF) on June 17.
Under the addendum, the Army took control of legislative powers after a Supreme Court verdict dismissed the elected parliament.
Mursi, a leader of Muslim Brotherhood, was elected president in June this year, at a time of a constitutional and legislative void in the country.
In the absence of a full-fledged constitution, it is still not clear whether the interim constitution gives the President the right to sack the Army chief.
The Muslim Brotherhood has historically been at loggerheads with the powerful Army, and relations haven't improved since the fall of Hosni Mubarak after a mass uprising last year.
Mursi also appointed Mahmoud Mekki, the deputy head of the Cassation Court, as his Vice President.
