The coalition's suit against the National Institutes of Health (NIH), backed by some Christian groups opposed to embryo research, also argued that the NIH policy took funds from researchers seeking to work with adult stem cells.
The Obama administration could appeal the decision or try to rewrite its guidelines to comply with US law.
In 1996, the US congress enacted legislation known as the Dickey-Wicker amendment, banning federal funding for research in which human embryos are either destroyed or discarded.
George Bush, the former US president, issued a directive in 2001 banning federal funding for research into stem lines created after that date.
But Obama, fulfilling a campaign promise, signed an executive order last year to expand research that supporters believe could uncover cures for serious ailments from diabetes to paralysis.
However the Obama administration argued that the research does not require disposal or destruction of the embryos, which were created for in-vitro fertilization treatments but never used.
Lamberth rejected that distinction in his ruling on Monday.
Researchers believe that stem cells, so-called because they are the foundation for all human cells, provide two promising avenues for scientists.
Firstly, they can be used for research that cannot be performed inside the body.
But scientists believe they can also coax the foundational cells into cardiac, pancreatic or brain cells to replace damaged or infected cells and allow tissue or organs to
There are three types of stem cells currently being examined for their potential medical research value.
Embryonic stem cells, which are extracted from human embryos; adult stem cells, which are taken from the body or from elements discarded after birth, such the umbilical cord; and induced pluripotent stem cells - adult stem cells that have been
genetically modified to resemble embryonic stem cells.
In reversing the ban put in place by his predecessor, Obama pointed to the potential breakthroughs the research could yield, and he rejected the "false choice" between sound science and moral values.