The Home Secretary has acted acted unlawfully and irrationally by freezing the level of government financial support for asylum seekers, the High Court has ruled.
A judge quashed Theresa May's decision not to increase cash payments for essential living needs while asylum applications are processed, a period when applicants are not allowed to work.
Mr Justice Popplewell, sitting in London, ruled: "In my judgment, the information used by the Secretary of State to set the rate of asylum support was simply insufficient to reach a rational decision to freeze rates."
In what charities working with asylum seekers welcomed as "a landmark ruling", he ordered Mrs May to reach a new decision by August 9 taking into account the guidance in his judgment.
A Home Office spokesman said: "We are disappointed with the court's judgment. We are looking at all options, including appealing."
A Home Office statement said increasing payments could encourage spurious asylum claims which could clog up the system and make it harder for those with a genuine fear of persecution to obtain vital support.
Payment levels were reviewed periodically to ensure they were adequate to meet essential living needs.
A further look at payment levels - about £36 a week for a single adult - was planned and would take into account the court's findings, as well as more up-to-date information, said the statement.
The court heard Parliament was told last June that the level of support for adult asylum-seekers and their children would be frozen for the financial year 2013/14.
There has been no increase since April 2011.
The judge ruled freezing payment levels amounted to "a reduction in real terms from what was regarded in 2007 as the bare minimum level necessary to avoid destitution".
The legal challenge was brought by Refugee Action, which said the Home Secretary had set a "cripplingly low level of financial support" for more than 23,000 people, many of whom were living in poverty and isolation.
Today's ruling was welcomed by the Children's Society, Freedom from Torture, Still Human Still Here, the Refugee Council, Red Cross and Helen Bamber Foundation who had all joined the fight for increased payments under section 95 of the Immigration and Asylum Act 1999.
They submitted that when the support system was introduced the Government stated that the level of support under section 95 was to be set at 70% of income support levels for adults.
Until 2008, the rates were broadly increased in line with increases made to income support payments. Then the link was broken.
Refugee Action chief executive Dave Garratt said: "Every day at Refugee Action we see the human impact of this unlawful Home Office policy which robs individuals and families of their dignity."
Matthew Reed, chief executive of The Children's Society, said: "Today's landmark ruling sends a clear signal to the government that it must stop forcing families and children - who are seeking safety from violence and persecution - into poverty.
"Financial support for children and families seeking protection in the UK can be as little as half that given to those on mainstream benefits, and they are not allowed to work.
"The Government must follow the High Court's ruling and make sure children and their families who are seeking protection in the UK get the support they need to live with dignity."
Freedom from Torture chief executive Keith Best welcomed today's ruling as "a wake-up call" that more needed to be done to assist asylum seekers who were victims of torture.
The National Aids Trust (Nat) said it has seen asylum seekers with HIV unable to pay for adequate food, clothing and heating.
Refugee Council chief executive Maurice Wren said: "This is a landmark judgment which recognises that we should not force some of the most vulnerable people in our society into poverty.
"It's extremely disappointing to hear that the Home Office may appeal rather than focusing on overhauling the system to make it more humane.
"The Government has a duty to ensure that the system which is supposed to protect people does not cause them further harm."