Hodgson found himself under intense pressure at Liverpool following the disappointing 3-1 defeat to Blackburn in midweek.
Liverpool are languishing in 12th spot in the Premier League and are sitting just four points above the drop zone.
The 63-year-old refused to answer questions on his future following the defeat at Ewood Park and speculation over his future intensified after his pre-match media briefing on Friday was cancelled.
The club have turned to former player and manager Dalglish to take up the reins for the rest of the campaign and try and rescue a wretched campaign for the Merseyside titans.
Dalglish, who wanted to return as manager before the appointment of Hodgson in the summer, will now take charge of the side for this weekend's FA Cup showdown with arch-rivals Manchester United at Old Trafford.
In a statement on the club's website, the club's principal owner John Henry said: "We are grateful for Roy's efforts over the past six months, but both parties thought it in the best interests of the club that he stand down from his position as team manager.
"We wish him all the best for the future."
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