The king announced his decision to sack the government on state radio on Tuesday, but shortly afterwards communications links between Kathmandu and the rest of the world appeared to be cut.
King Gyanendra announced he would form a new government under his own leadership, following the dismissal of the prime minister and his ruling coalition.
"For the larger interest of the Nepalese general public, the nation and democracy and people's fundamental rights, we have decided to form a new government under my own chairmanship," he said.
India's NDTV television channel said the monarch had placed politicians under house arrest, but no further details were available.
The strategic Himalayan nation, sandwiched between India and China, is locked in a bitter three-way struggle among the king, political parties and Maoist rebels.
The king is often accused of overstepping his powers and only reappointed Prime Minister Sher Bahadur Deuba last June, two years after sacking him for failing to tackle the long-standing Maoist revolt against the monarchy and to call an election.
This time, Deuba had promised to go ahead with the election despite the civil war and the refusal of the Maoists to come to peace talks by a 13 January deadline.
Nepal's Prime Minister Deuba was
sacked before, two years ago
But many members of Deuba's own cabinet were known to be unhappy with the plan to hold polls, saying it was unrealistic in a country where the rebels control much of the countryside.
The rebels have been fighting since 1996 to replace the monarchy with a communist republic in a revolt that has cost about 11,000 lives.
This is the fourth time the king has sacked a prime minister in less than three years. Nepal has had no parliament since 2002.