It follows tensions between the two countries that mounted after a military coup ousted the country's Islamist president this summer.
In a quick reaction, Turkey reciprocated by declaring the Egyptian ambassador "persona non grata" and downgrading relations with Egypt to the same level. Egypt's ambassador had not been in the country since August over the turmoil.
Saturday's decisions, which fall short of closing diplomatic missions in the two countries, are a dramatic reversal of the warming relations between the two countries over the past year.
Egypt's Foreign Ministry said it considered the Turkish envoy "persona non grata" and asked him to leave the country. The ministry said it will scale back its diplomatic relations with Turkey to the level of charge d'affaires.
"This (Turkish) leadership has persisted in its unacceptable and unjustified positions by trying to turn the international community against Egyptian interests and ... by making statements that can only be described as an offense to the popular will," the Foreign Ministry statement said.
A Turkish ministry statement said Egypt's interim government, "which came to power in exceptional circumstances," was responsible for the deteriorating relations.
"The deep-rooted ties and bonds of brotherhood between the people of Turkey and Egypt will remain," the statement said. "We hope that stability and democracy in Egypt is restored as soon as possible and that relations between the two countries are normalised."
Turkish president Abdullah Gul told reporters that he hoped the two country's relations "will be restored soon."
The Turkish president was the first to visit Egypt after the fall of Mr Mubarak in February 2011.
Turkey's Islamic-rooted ruling party strongly backed toppled Egyptian president Mr Morsi - a leading figure in Egypt's Muslim Brotherhood - as an example for the Arab world of a democratically elected Islamist leader.
Turkey criticised his popularly backed overthrow in July by Egypt's military, while also criticising the West for what it deemed as a weak response to the coup.
Turkey and Egypt previously recalled their ambassadors in August after Turkey condemned the ouster and a subsequent bloody crackdown on pro-Morsi protests. Turkey's ambassador returned weeks later, but Egypt declined to return its envoy to Ankara.
Saturday's decision comes after Turkish prime minister Recep Tayyip Erdogan renewed his criticism of Egypt's new leaders, dismissing the trial of Mr Morsi on charges of inciting murder of his opponents while in office and describing the situation in Egypt as a "humanitarian drama."
Egypt's interim president Adly Mansour has said that Turkey should have relations with "Egypt and its people - and not with leaders of a certain group."