Labour MPs have unanimously endorsed leader David Shearer in an afternoon caucus, while MP David Cunliffe has been stripped of his front bench position and his portfolios.
Labour leader David Shearer announced the demotion after he secured a unanimous endorsement from his caucus at an urgent meeting this afternoon.
Mr Shearer said Mr Cunliffe was unable to show loyalty.
"His actions at the weekend were disappointing not only to me but to many party members. That, along with his repeated failure to quell speculation about the leadership means that I no longer have confidence in him."
He said there was a "robust discussion" in caucus and it was possible Mr Cunliffe could return to the front bench if he proved his loyalty.
"I regret having to take the action I have today but he has left me with no alternative."
It followed a weekend in which Mr Cunliffe repeatedly refused to rule out a challenge of Mr Shearer during the party's annual conference. Mr Cunliffe later said he would endorse Mr Shearer but would not commit to that when Mr Shearer faces a formal confidence vote in February.
That vote will be held under new party rules which allow 40% of caucus to force a leadership contest by refusing to endorse him.
Mr Cunliffe avoided waiting media when he arrived at Parliament but waved quickly as he entered the caucus room.
Mr Cunliffe posted an online message this evening which read:
"Thank you to the hundreds of social media friends who have messaged in friendship and support in recent days. I wish I could express my gratitude for your kindness and my wish that we all might work together for a better New Zealand. Unfortunately I am not at liberty to comment further at this time.''
Several MPs have been openly angry about Mr Cunliffe's behaviour at the conference, saying he had openly undermined both Mr Shearer and former leader Phil Goff. However his allies have argued that no leadership challenge was planned.
Mana MP Kris Faafoi said he was pleased Mr Shearer had been fully endorsed by caucus.
"It's time to get on with it, and I think people want us to get on with it -we should get on with it and it's been dealt with.''
He said he did not have any advice for Mr Cunliffe.
Fellow MP Sue Moroney would not comment.
Speaking after today's vote, Prime Minister John Key said it showed Labour was still a "deeply divided" caucus.
"They haven't actually resolved their issues. They fundamentally don't like each other. They can't agree on the direction they are going in and they can't actually agree on their leader.
"In the weekend they were essentially on display of what they think of each other. Yep, they'll put a united front on it today but it's not going to fool anyone. At some point in the future, David Cunliffe is coming back after David Shearer.
"They are consumed by the internal workings of the Labour Party and we are focused on what is happening here on the global stage and how we can advance New Zealand's position in the world."By Claire Trevett @CTrevettNZH Email Claire