A Supreme Court statement said eight of 15 justices had ruled against an amendment passed by parliament in July which scraps the "reasonableness" clause, used by the court to overturn government decisions which are deemed unconstitutional.
"This is due to the severe and unprecedented damage to the basic characteristics of the State of Israel as a democratic state," the statement said.
Prime Minister Benjamin Netanyahu had argued the sweeping judicial reform agenda presented a year ago was necessary to rebalance powers between judges and politicians.
But his detractors warn the multi-pronged package could pave the way for authoritarian rule and be used by Netanyahu to quash possible convictions against him in his ongoing corruption trial, an accusation the premier denies.
Israel does not have a constitution or upper house of parliament.
The "reasonableness" measure -- part of one of the Basic Laws which form Israel's quasi-constitution -- was put in place to allow judges to determine whether a government had overreached its powers.
Justice Minister Yariv Levin, the architect of the judicial overhaul, said on Telegram that the ruling "takes away from millions of citizens their voice."
He slammed the judges for "taking into their hands all the powers, which in a democratic regime are divided in a balanced way between the three branches" of government.
'Historic decision'
Opposition leader Yair Lapid welcomed the verdict and warned of the resurgence of internal divisions in Israeli society.
"The Supreme Court faithfully fulfilled its role in protecting the citizens of Israel, and we give it our full backing," Lapid said on X, formerly Twitter.
And if the government "restarts the quarrel" over the court, "then they have learned nothing... from 87 days of war," he said, referring to the Israel-Hamas conflict.
Protest leaders, who before the war broke out on October 7 had mobilised tens of thousands of demonstrators weekly, also welcomed the ruling.
"The high court's ruling removes, at least for the moment, the sword of dictatorship from around our necks," said prominent organiser Shikma Bressler in a video statement.
"This is a historic decision," said in a statement the Movement for Quality Government in Israel, an anti-corruption group behind the court petition.
It accused the Netanyahu government of wanting "to govern without the judiciary" and hailed "a democracy that believes in separation of powers."
Protesters had rallied weekly against the government reforms since they were first unveiled in January 2022.
The "reasonableness" amendment, the only major part of the legal reform package to become law, was also one its most contentious steps as it sought to curb judicial oversight of the government.
When Netanyahu's allies voted to scrap the clause in July, opposition lawmakers stormed out of the chamber, shouting "shame."
The court has only cited "reasonableness" in a handful of decisions, including a high-profile ruling last year which barred a Netanyahu ally, Aryeh Deri, from serving in the cabinet because of a previous tax evasion conviction.
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