The Championship club made this known in a statement on its official website on Monday.
Pep has been an influential figure since joining City in March 2018.
The 43-year-old was appointed Caretaker Head Coach in June 2019 before becoming Head Coach in December.
“Pep Clotet has decided to step down, and the club has agreed to allow the 43-year-old to explore other coaching opportunities,” the statement read.
Reacting to the development, Birmingham City CEO, Dong Ren said: “Pep will depart with our very best wishes.
“Pep came in as a colleague, but he’ll leave as a friend with our gratitude.
“He has done a very good and thorough job for us and has been professional throughout, always putting the club before himself.”
Also reacting, Pep told the club’s official website: “It’s been a really difficult decision to take because it is a privilege to be part of the Blues family.
“I am very grateful to the club, its board and the supporters for placing their faith in me to lead the team this season.”
City currently sits in the sixteenth position on the Championship table with 47 points from 37 matches.
