The 27-year-old tore his lateral collateral and anterior cruciate ligaments in a domestic derby against Worcester Warriors at Sixways in January 2012 and hasn't played since.
Morgan explored every possible angle in an attempt to return to the sport, including a spell in the United States with world-renowned knee specialist Bill Knowles, but he has now confirmed that his knee will not be able to stand up to the demands of professional rugby.
"It's been such a difficult decision. Even though I've had a long time to consider this moment, it doesn't make it any easier," said Morgan, who won two caps for his country in 2007.
"The frustrating element is that we've actually made so much progress with my knee. However, I have had to reluctantly accept that the knee would not be able to cope with the stresses of matches week in and week out, as well as regular training sessions. It would just be too much.
"There have been so many great moments. I've loved every minute of my time as a Gloucester player, and I represented my country. Not many people can say that.
"It's disappointing that I'm not able to bow out in the way that I'd like, but I've had so many highs and made so many great friends. You can't have any regrets when you look at it like that."
Morgan made 131 appearances for Gloucester following his debut back in 2005, scoring a total of 150 points courtesy of 30 tries.
He featured in the Heineken Cup on 17 occasions, starting 15 times and coming off the bench twice, with his last appearance at Europe's top table coming in the 23-19 win over Connacht at Kingsholm in mid-December 2011.
Morgan also played 11 games in the Amlin Challenge Cup, with six of those coming in the club's tournament-winning season of 2005/06.
"It's always desperately sad when a player has to retire due to injury. In my time at Gloucester, we've lost the services of Alex Brown and now Olly. Both were class players," said Gloucester's director of rugby, Nigel Davies.
"I rated Olly as a player even before I arrived at the club. Since then, my admiration for him as a man has grown immeasurably as I've watched him dedicate himself to overcoming the injury.
"He's given it absolutely everything, and I know it's been a tough decision for him. Olly has been a great servant to the club and I'm sure has a bright future ahead of him."