Egypt's administrative court suspended on Tuesday a justice ministry decision to allow the ruling military powers to arrest civilians, a judicial source said.
The court took the decision after reviewing an appeal filed by 17 rights groups against the controversial decree passed on June 13.
"The decision creates extraordinary powers that have no basis in law," the groups had said in a statement, describing the order as "a blatant circumvention of the official end of the state of emergency."
"The decision could put in place far worse restrictions than those of the state of emergency," the statement said.
The military has said the decree was necessary after the end of a decades-long state of emergency while the army remained on the streets.
The decision infuriated activists and protesters, who have campaigned for years for an end to the state of emergency, which granted police wide powers of arrest and was often used to curb dissent.
Ousted president Hosni Mubarak had called in the army during an uprising last year in which protesters torched police stations. The military is scheduled to hand power to president-elect Mohamed Morsi on June 30.
The Egyptian Initiative for Personal Rights watchdog welcomed the court decision, saying the decree had allowed the military the right to arrest people for "resisting the rulers and insulting them."
"The groups that filed the appeal believed that many of the crimes mentioned in the decree are included in the right of Egyptians to peacefully express political views opposing the regime," it said in a statement.
The head of military justice Adel al-Mursi had said earlier this month that the decree was necessary after the state of emergency expired on May 31.
"The decision fills a legal vacuum, as the army is still on the streets even after the state of emergency was lifted," Adel al-Mursi, the head of military justice, told reporters.
The United States said that it was reviewing the decision.
"I think I will take some time to review what has happened. But if it is in support of human rights and dignity for the Egyptian people, then it would be a good move," State Department spokeswoman Victoria Nuland told reporters in Washington.
The measure came just days before a presidential election runoff between ex-premier Ahmed Shafiq and Morsi, the Muslim Brotherhood candidate who was announced the winner on Sunday.
Morsi has since been conducting talks with the military rulers about their powers after they transfer control to him on June 30.
In other decrees this month, the military assumed legislative powers after dissolving parliament following a court order and formed a national security council dominated by generals which will have a large say in policy-making.
It also reserves the right to pick a new constituent assembly to draft the country's next constitution.
The current assembly, elected by parliament, may also be dissolved by a court decision expected on September 1.