The Columbia district circuit appeals court said in a 2-1 decision that the Environmental Protection Agency had exceeded its mandate with the rule, which was to limit sulphur dioxide and nitrogen oxide emissions from power plants in 28 mostly eastern states and Texas.

The court sent the cross-state air pollution rule for revision, telling the agency to administer its existing clean air interstate rule – the Bush-era regulation that it was updating – in the interim. The EPA said it was reviewing the ruling.

The decision was cheered by Republicans who have made the EPA and President Barack Obama's environmental policies a major campaign issue ahead of November elections. The agency is risking a fragile economic recovery by saddling US industries with costly new rules, Republicans say.

"The Obama-EPA continues to demonstrate that it will stop at nothing in its determination to kill coal," said Republican senator James Inhofe, one of the most vocal EPA opponents in the US Senate.

Power groups, which had argued that they could not meet the deadline or bear the financial burden of installing costly new equipment, welcomed the court's decision. The EPA had estimated it would cost $800m (£506m) annually from 2014.

"The court was clear in finding that EPA had overstepped its legal authority in developing the rule," said Scott Segal, director of the Electric Reliability Coordinating Council.

Coal company stocks, which have suffered this year as cheap natural gas undercut demand, soared after the ruling.

US natural gas futures briefly fell more than 3% as traders bet it would mean less demand for the cleaner fuel over the coming months.

But some analysts see little material impact from the ruling, with dozens of coal-fired plants set to close due to other EPA regulations.

The EPA's rule was designed to reduce sulphur dioxide emissions by 73% and nitrogen oxide by 54% at coal-fired power plants from 2005 levels, improving health for over 240 million people, according to the agency. It said emissions from the plants cause acid rain and smog.

Two of the three judges ruling on the case said the EPA had exceeded its "jurisdictional limits" in interpreting the Clean Air Act and imposed "massive emission reduction requirements" on upwind states.

"By doing so, EPA departed from its consistent prior approach to implementing the good neighbour provision and violated the [Clean Air Act]," judge Brett Kavanaugh said in the court's ruling.

Environmental groups warned that the decision would put lives at risk and urged the EPA to appeal against the decision.

"The court's decision significantly imperils long overdue clean air safeguards for millions of Americans," said Vickie Patton, general counsel of the Environmental Defense Fund.

Patton said the EPA should move in parallel to "swiftly put in place replacement protections" and to ask the three-judge panel and the full court to rehear the case.