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The company confirmed yesterday domestic flights would cease over the next two months to concentrate on international, including transtasman, routes.
The airline's Dunedin and Queenstown services to Auckland are scheduled to end on September 15.
University of Otago Centre for Air Transport Research director Dr David Duval said he was not surprised by the decision, as it was difficult for a country New Zealand's size to sustain three domestic airlines.
The news was "not good" for Dunedin, which would be reduced to having the one domestic carrier, Air New Zealand.
The entry of Pacific Blue and Jetstar had helped reduce domestic ticket prices, and "it remains to be seen whether the market now expects lower fares".
It also raised questions about the proposed alliance between Pacific Blue and Air New Zealand to code share on transtasman flights.
Pacific Blue spokesman Phil Boeyen said the domestic withdrawal would not affect the proposed alliance, which is before the Ministry of Transport, and the airline remained committed to transtasman services from Queenstown and Dunedin.
The Otago routes had performed well but the airline could no longer afford to offer domestic ticket fares cheaper than taxi rides to some airports.
There would be no Pacific Blue job losses, and the airline was in talks with contractors, including ground operation staff affected by the changes, he said.
Dunedin International Airport chief executive John McCall said the net effect for the airport and the city was negative, as it would lose seven flights a week to Auckland, and gain an additional service to Brisbane.
"It will have a significant impact on our financial position," he said.
The reduction in competition could drive up prices and reduce demand, and the airport would continue to talk to other airlines to fill the void left by Pacific Blue.
Queenstown Airport chief executive Steve Sanderson said his disappointment was tempered by the airline's commitment to the burgeoning transtasman market.
The airline offered two services a week to Queenstown from Auckland, and other airlines would cater for those additional passengers, he said.
Following Pacific Blue's announcement, Jetstar confirmed it would develop its domestic capacity to "further expand our fledging domestic New Zealand operations", chief executive Bruce Buchanan said.
Two new A320 aircraft will be based in New Zealand within the next year, supporting the launch of the Melbourne and Auckland services into Queenstown.
An airline spokesman declined to comment whether Dunedin would be added to its five existing domestic routes, Destination Queenstown marketing general manager Graham Budd said the Pacific Blue move was "not entirely surprising" because there was a feeling that three airlines would find it hard in the domestic market.
Queenstown Lakes deputy mayor John S.
Wilson, of Wanaka, said the loss of the domestic flights would likely be offset by an increase in transtasman flights direct to Queenstown.
"I think more passengers coming directly into Queenstown on transtasman flights is likely to bring greater economic benefit than the loss of two domestic flights a week."