"Diplomatic relations are not broken. But Saudi Arabia's ambassador has been recalled," Swedish foreign ministry spokesman Erik Boman told the AFP news agency on Wednesday.
Saudi Arabia confirmed the decision, accusing Sweden's foreign minister of "flagrant interference" in its internal affairs after she criticised the country's human rights record.
Margot Wallström's criticism was "harmful to the kingdom," the Saudi foreign ministry said in a statement, adding that it represented a "flagrant interference in internal affairs, which is not accepted in international conventions."
"This is not a game. It's a serious issue that must be treated seriously," Social Democrat Prime Minister Stefan Löfven told public broadcaster Swedish Radio on Wednesday.
His party had come under intense pressure to abandon the deal from coalition partners the Green Party.
The Social Democrats refused to cite human rights as a motive for the decision but Wallström had said her opening speech at Monday's meeting in Cairo was blocked by the Saudis for her pro-democracy stance in the region.
The deal involved exchanges of military products, logistics, technology and training. The Swedish defence minister said only cooperation in medicine and gender studies would remain on offer.
"In practical terms, there is no military cooperation," the minister, Peter Hultqvist, told public broadcaster SVT.
"What we have is an open invitation to partake in medical and gender training, but the Saudi side has not shown any interest," he added.
The deal on military cooperation — signed by a left-wing government in 2005 and renewed in 2010 — has come under domestic fire after journalists in 2011 revealed that Sweden had secretly helped the Saudis construct a weapons factory.
A sharp debate over the decision to end the agreement broke has broken out in Sweden since the news emerged on Tuesday.
The leader of the Swedish Left Party Jonas Sjöstedt referred to the news to end the deal as a “victory” on Tuesday and wrote on Twitter: “Credible feminist politics demanded this.”
But former Foreign Minister Carl Bildt issued sharp criticism of the government.
"This is not least about Sweden's credibility as a contractual partner. That credibility is important to a relatively small country like Sweden,” he wrote on his blog.
“What has happened is unfortunate. Sweden has been damaged,” he added.
Sweden's decision to scrap the agreement followed years of discussions and "is actually not surprising after such a heated debate," political scientist Thord Janson at the University of Gothenburg told AFP.
"What surprised (me) more was the signing of this agreement 10 years ago, when Saudi Arabia was more or less considered a normal country," he added.
Social Democrat Prime Minister Stefan Löfven's government came to power in October 2014 announcing a "feminist foreign policy" and promptly decided to recognise Palestine, becoming the first major Western European nation to do so.
The decision caused a diplomatic spat with Israel, which temporarily recalled its ambassador from Sweden.
Commenting on the severed military ties, liberal writer Fredrik Segerfeldt wrote on Wednesday that Sweden's objective was "to become a moral power" on the world stage.
Such policies recall the bold statements of murdered Social Democrat Prime Minister Olof Palme, who made radically anti-US remarks on the Vietnam War and slammed the apartheid regime in South Africa as well as the rule of Augusto Pinochet in Chile before being shot dead on a Stockholm street in 1986.
But taking a stance against Saudi Arabia today risked Sweden's credibility as a business partner, according to some centre-right opposition politicians and the Swedish business community.
"Foreign policy is not only about other countries," right-wing daily Svenska Dagbladet wrote in an editorial, noting that Swedish industry "must be allowed to trade… even with dictatorships".