It was Dortmund’s fourth loss of the season and left them five points behind Bundesliga leaders Bayern Munich.
Favre, whose contract was due to expire at the end of the season, called the loss a “disaster”.
Speaking after the game, he said: “It was bad. We weren’t good at winning the ball. We have made too many big mistakes. It is difficult to explain. If you’re not good at winning the ball, and I mean the whole team, then you’ve got a problem. ”
Favre was briefed on the club’s decision following the loss to Stuttgart on Saturday. Edin Terzic, who worked as Favre’s assistant coach, will take over the training of the first team for the time being.
Dortmund, who finished second last season, have won just one of their last five games in the German top flight.
The club have lost six of their eight home games without supporters. They had lost just one in 32 at home to Favre with fans in the stands.
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