The Chilean coach joined City from Malaga in 2013 and has led them to glory in the Premier League and League Cup, though his side missed out on last season's title to Chelsea.
City have been said to be exploring other options this summer and have been heavily linked to Bayern Munich coach Pep Guardiola, however, on the eve of the opening weekend of the Premier League campaign, they have confirmed that the coach will remain at the Etihad Stadium until June 2017.
"I am proud to manage Manchester City and am therefore very pleased to have agreed this contract," Pellegrini told the club's official website after committing his future to the club.
"I have a very good quality group of players and a great team of people to work with on and off the field and at all levels of the club.
"I am focussed on the coming season and confident that my team and I will respond to the constant support shown to us by everyone including of course our fantastic fans."
The club's chief executive, Ferran Soriano, was full of praise for the ex-Real Madrid boss.
The club's chief executive, Ferran Soriano, was full of praise for the ex-Real Madrid boss.
"We are delighted to reach this agreement with Manuel Pellegrini who has already contributed so much to the development of Manchester City in his first two years with us and we look forward to further progress in the seasons ahead," he added.
"This agreement allows Manuel to focus on the challenge of guiding a team capable of both fighting for domestic titles and competing for European honours."
