The surprise announcement sent the price of gold plummeting more than $9 lower to $279.90 an ounce, close to the lowest level for 20 years. The Treasury's decision was seen in the gold market as a forerunner of similar announcements by other central banks and the International Monetary Fund.
Indeed, the UK move sets an example for the IMF, which Gordon Brown has been pushing to sell some of its gold reserves in order to finance more generous debt relief for poor countries. Group of Seven leaders are expected to announce the plan at their summit in Koln next month.
The World Gold Council described the news as "damaging". It suggested the move was a actually a precursor to UK entry into the single currency, pre-empting the referendum on membership.
The shock hit share prices in gold-mining. South Africa's All-Share index fell by nearly 1 per cent, with AngloGold's price down nearly 5 per cent at 278.2 rand. The South African currency also weakened.
The proceeds from the UK's sale of 125 tonnes (around 4 million fine troy ounces) of gold - 3 per cent of total reserves - this financial year will be invested instead in interest-bearing dollar, euro and yen assets. Over the next few years the plan is to reduce gold reserves from 715 tonnes to 300 tonnes.
The sales will take place through a series of auctions every other month starting on 6 July. Members of the London Bullion Market Association and other institutions with gold accounts at the Bank of England, will be allowed to enter bids.
Andy Smith, commodities analyst at Mitsui, said: "The auction method ... will allow the market to gauge the extent of the risk."
Successful bidders will be allocated 400 ounce ingots, known as "London Good Delivery Bars" containing at least 995 parts per 1,000 pure gold, sitting in the Bank's vaults in Threadneedle Street. Although they will be encouraged to leave the gold in accounts at the Bank, they will also be allowed to take physical delivery of the bars.
The Treasury has left itself some leeway to alter the size and timing of the auctions depending on market conditions. A spokesman said: "We do not intend to try and play the market."
The UK is not the first country to reduce the level of gold in its reserves. Canada sold gold in 1979. More recently Belgium and the Netherlands have sold large amounts, as did Australia and Argentina in 1997.
Last month Switzerland severed the link between the Swiss franc and gold and passed legislation permitting its Central Bank to reduce its holdings by up to 1,300 tonnes. The US, Germany, France and Italy will hold the largest remaining gold reserves.
The UK's reserves are worth nearly $37bn, including the gold, while foreign currency liabilities amount to $22bn. The 715 tonnes of gold are worth about $6.5bn, or roughly half the net reserves.
The physical amount of gold held in the UK's reserves has barely changed since 1970. But the market value, having soared to reach a peak of about $15bn in 1980, has fallen substantially.
Outlook, page 22Reuse content