Military sources said that Mursi, who was elected in June but with constitutional powers restricted by the generals, had consulted Field Marshal Hussein Tantawi, whose Supreme Council of the Armed Forces (SCAF) had taken over after the ouster of former President Hosni Mubarak and General Sami Enan, the military chief of staff, before asking both men to retire.
The move might indicate to a significant reordering of the political forces of Egypt, which is waiting for a new constitution after sixty years of uninterrupted army rule.
A presidential spokesperson said that General Abdellatif Sisi was appointed as the chief of armed forces and defence minister. General Enan, who was close to the US military, was replaced by General Sidki Sobhi. Both Tantwai and Enan were made advisers to the president.
General Mohamed el-Assar of the military council said the decision was taken after consulting the field marshall and the rest of the military council. Mursi also appointed Mahmoud Mekky, a judge, as his vice president. Mekky is the brother of Ahmed Mekky, the newly-appointed Justice Minister and a vocal critic of vote-rigging under Mubarak.
The steps taken by the new Egyptian President have raised concerns for Irsael and the West. Mursi, who although said that he would abide by Cairo's treaties with Israel and others, was growing impatient with the army following the violence in the Sinai desert, which created trouble with Israel and the Gaza Strip enclave of the Palestinians recently.
Mursi, whose Brotherhood movement had renounced violence in the past, sacked Egypt's intelligence chief last week following an assault in which Islamist militants killed 16 Egyptian guards near the Israeli border. No group has claimed responsibility for the killings. Egyptian troops made a retaliation when they killed five Islamist militants on Sunday after raiding their hideout near an isolated border with Israel, security sources said.
The latest clash is a part of the biggest military operation in the region since Egypt's 1973 war with Israel, which was followed by a peace treaty six years later.
(With Reuters inputs)