Ms Berejiklian and Treasurer Dominic Perrottet said the about-face would ensure Sydney had two world-class museums in a boost for the arts,tourism and employment.
Pressure on the government to rethink its controversial decision to close the inner-city site has been increasing in recent weeks as it emerged the Ultimo collection could be dispersed across the state.
The new Powerhouse is scheduled to open in late 2024 on the banks of the Parramatta River while the Ultimo site closed its heritage halls to general public entry on July 1. The rest of the museum was due to close in July 2021.
The government had planned to sell the site at Ultimo for as much as $195 million,with the proceeds to go to the cost of building the new museum at Parramatta.
But the government will now explore if some of the funds earmarked for relocation costs can be used on renovating the Ultimo site.
Ms Berejiklian said the decision meant the Museum of Applied Arts&Sciences would soon boast four centres,including the Powerhouse at Parramatta and Ultimo.