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Royle said: "I would like to thank everyone involved at Ipswich Town - the fantastic staff and the players for their support and for giving their best at all times.
"As the chairman said, we part extremely amicably and I wish the club, its staff and the supporters nothing but the very best for the future."
Sheepshanks himself said: "Joe and I have met today and agreed that this is the right moment to go our separate ways.
"The parting is entirely amicable. I would like to place on record our warm appreciation and thanks for the tremendous job that Joe has done at Ipswich during his tenure, managing the club initially through turbulent times and building a side that reached the play-offs in two out of the last three seasons."
Royle took over the helm from George Burley in October of the 2003/2004 season, following the Blues relegation to the Premiership.
The club is now actively seeking a new manager, with former player and once caretaker manager Tony Mowbray already being linked but the prospect of the vacant Middlesborough job could be his first choice.