Egypt's Islamist President Mohamed Morsi has emerged empowered by a "revolutionary" decision to dismiss his powerful defence minister and curb the military's sweeping powers, media said Monday.

In a surprise move, Morsi on Sunday retired Defence Minister Field Marshal Hussein Tantawi, 76, and armed forces chief of staff Sami Anan and scrapped a constitutional document that gave the military legislative and other powers.

The state-run Al-Akhbar newspaper said the dismissal of Tantawi, who ruled Egypt for more than a year after massive streets protests forced veteran strongman Hosni Mubarak to step down in February 2011, was a "revolutionary decision."

"The Brothers officially in power," declared the independent Al-Watan daily, referring to the Muslim Brotherhood, the Islamist group which backs Morsi and through whose ranks he rose before his election triumph.

The independent daily Al-Shorouk said Morsi had accumulated "much bigger prerogatives than those of Mubarak."

Thousands of Islamist supporters on Sunday flooded into Cairo's Tahrir Square -- cradle of the revolution that toppled Mubarak last year -- to celebrate.

"The people support the president's decision," the crowd chanted.

In a late-night speech, Morsi denied trying to marginalise the army, saying he was acting in the interests of the country.

"I never intended, through my decisions, to marginalise or be unjust towards anyone, but rather to act so that we advance towards a better future, with a new generation, long-awaited new blood," Morsi said.

Morsi also amended the interim constitution to deny the military any role in public policy-making, the budget or legislation, or the right to pick a constituent assembly drafting a permanent constitution for post-Mubarak Egypt.

Mourad Ali, a senior official with the Brotherhood's Freedom and Justice Party, which fielded Morsi in the May-June presidential polls, praised the president.

"Given the circumstances, this is the right time to make changes in the military institution," the Islamist official said. "He is a strong president, and he is exercising his authority."

The Cairo stock exchange reacted positively with the EGX-30 index rising 1.5%. "Morsi's announcements are seen as a boost to stability," said financial analyst Mustafa Badra.

-- Israel watches with 'concern' --

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Sunday's announcements marked a new twist in uneasy relations between Morsi and the army, testing the balance of power between the first civilian president in Egypt's history and a military that had moved to limit his power.

Tantawi, who had served as Mubarak's defence minister for two decades, was replaced by Abdel Fattah al-Sissi, in his 50s and the youngest member of the Supreme Council of the Armed Forces.

Both Tantawi and Anan were awarded Egypt's highest honour and were retained as presidential advisers.

Morsi also gave other members of the SCAF key public sector jobs. Navy chief Vice Admiral Mohab Mamish was named head of the Suez Canal Authority, one of Egypt's top revenue earners.

Morsi also decided to appoint a vice president.

He named judge Mahmud Mekki as his deputy, MENA reported, making him only the second vice president to be named in Egypt in 30 years.

Sunday's shakeup is the latest in a series of moves by Morsi a week after a deadly attack on the Egyptian military in the Sinai prompted an unprecedented military campaign in the lawless peninsula.

Last week Morsi replaced his spy chief and dismissed top security and political officials in the Sinai as well.

Washington, which is a key military aid donor to Egypt, said it hoped to continue to work closely with the Cairo military and political leadership.

"The new defence minister is someone who's known to us, he comes from within the ranks of the SCAF and we believe we'll be able to continue the strong partnership that we have with Egypt," said Pentagon press secretary George Little said.

US Defense Secretary Leon Panetta "looks forward" to calling him "at the earliest possible moment," he added.

But in Israel, a government official expressed "great concern" over developments in Egypt while media suggested the removal of figures such as Tantawi would force Israel to seek new interlocutors.

Israel and Egypt signed a peace treaty in 1979, and although ties were frosty, security cooperation between the two countries' armies remained solid.

"The change of security and military leadership in Egypt will require Israel to open channels of dialogue with the new figures, not all of whom are familiar faces," an analysis in Maariv newspaper said.

"It is too early to say what will happen because everything is evolving in Egypt, but we are following what is happening there with great concern," the Israeli official told AFP.