The 63-year-old was informed of the decision on Saturday evening, after the heavy loss against the Bundesliga new boys which left Dortmund five points behind Bundesliga leaders Bayern Munich.
Favre was appointed as manager of Dortmund after his impressive performance at French club Nice in July 2018, had led the club to the last 16 of the Champions League as group winners.
Assistant coach Edin Terzic will take charge of Dortmund until the end of the season on an interim basis and will lead the club for the first time against Werder Bremen in the Bundesliga on Tuesday.
Michael Zorc, Dortmund's sporting director, said the club's board came to the unanimous decision due to the "great risk" to the team's targets for the season.
Dortmund chief executive Hans-Joachim Watzke said: "We are all grateful to Lucien Favre for the superb job he has done over the last two-and-a-half years, achieving two runner-up finishes with his team.
"As a professional and as a person, Lucien Favre is beyond reproach."
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