The novel is set in a world dominated by a theocratic international organisation, the Magisterium (also commonly called "the Church"), which actively suppresses heresy. In this world, humans' individual souls naturally exist outside of their bodies in the form of sentient "dæmons": animals that constantly accompany, aid, and comfort their humans. Children's dæmons can freely and instantaneously change their appearance into that of any creature, extant or imagined; once they reach puberty, however, all people's dæmons settle into one permanent form.
Lyra Belacqua, an English girl on the cusp of puberty, has been allowed to run wild with her beloved dæmon, Pantalaimon, in the grounds of Jordan College— in her world's Oxford University—for her entire life, under the guardianship of the college's Master. One day, while awaiting the arrival of her uncle, Lord Asriel, Lyra sneaks into a wardrobe, in the hopes of spying on Asriel's lecture to the college's Scholars. Moments before Asriel is scheduled to begin the lecture, she witnesses a bottle of wine being poisoned by the Master, she warns Asriel not to drink it. Asriel then orders Lyra to return to her hiding place in the wardrobe a moment before the Scholars enter the room. From here, Lyra watches Asriel's lecture, thus learning of "Dust", the name given to strangely behaving elementary particles that are inexplicably attracted to adults more than children. The lecture sparks Lyra's interest in Arctic exploration when Asriel reveals groundbreaking images of a city skyline in some parallel universe that can be viewed through the northern lights. The purpose of the lecture is to convince the Scholars that other worlds exist so that they will fund Asriel's ongoing research, which the oppressive Church considers heretical.
After Asriel leaves Jordan, successful in his effort for financial backing, Lyra begins hearing rumours of the Gobblers, a mysterious group that has been kidnapping children throughout England, allegedly for the purposes of torture or experimentation. Shortly after her own friend Roger Parslow goes missing, Lyra meets Mrs Coulter, a beautiful, enchanting, and worldly woman, and eagerly agrees when invited by the Master to go and live with her. Before Lyra leaves Jordan, the Master secretly entrusts Lyra with an alethiometer, a "truth teller" which resembles a four-handed pocket watch that will truthfully answer any possible question asked by a skilled user. Although unable to read or understand its complex symbols at first, Lyra takes it with her, and gradually begins to use the device fluently over the course of the narrative — which, it is later revealed, no adult can do as well as she. Lyra believes that the Master, who tried to poison Asriel, gives Lyra the alethiometer so that she will deliver it to Asriel as a reparation, or token of apology, for the earlier attempt on his life. It later becomes clear that the Master only attempted to poison Asriel under great pressure from the Church.
After living for several weeks with Mrs Coulter, Lyra suddenly realises that Mrs Coulter is the leader of the General Oblation Board: the secret, Church-approved, child-stealing organisation that kids have been calling "the Gobblers". Horrified, Lyra flees and is rescued in London by the Gyptians, a canal-faring nomadic people whose children comprise many of Lyra's closest playmates at Jordan. The Gyptians reveal that Lord Asriel and Mrs Coulter are in fact Lyra's father and mother. The Gyptians tell Lyra the true story of her parents' history and she begins life with the Gyptians. The Gyptians have been hit hardest by the Gobblers' kidnapping activities and, during an emergency convocation of the Gyptian clans, they ultimately plan an expedition to the Arctic to rescue all of the missing children, including Roger.
On a stop in Trollesund, Lyra meets Iorek Byrnison, an outcast prince of the panserbjørne, or sapient "armoured bears". His armour, stolen from him by the villagers, is akin to his soul, and without it Iorek is bound in servitude to the village. Lyra uses her alethiometer to locate it for him and in return he—and an old friend of his, an aeronaut named Lee Scoresby—agree to help her on her quest. She also learns that Lord Asriel is now being held in exile by the panserbjørne at Svalbard.
The Trollesund consul of the witches tells the Gyptians that there is a prophecy about Lyra's destiny, which she must not know about, and that it seems the witch clans are choosing sides in preparation for some imminent war. The party consisting of Gyptians, Iorek Byrnison, Lee Scoresby, and Lyra continue moving north toward where they are told the Gobblers hold the children, at a place called Bolvangar. Guided by the alethiometer, Lyra detours at a village and finds, to her horror, a boy who has been severed from his dæmon. Lyra understands now that the Gobblers are deliberately cutting the bond between human and dæmon (a process called "intercision"): an uncanny notion equal to a human body being split from its soul. Though Lyra brings the boy back to her party, his psychological devastation overcomes him and he dies. In the Arctic wilderness, the party is then attacked by bounty hunters and Lyra, captured, is taken directly to Bolvangar: a research station for the General Oblation Board. Superficially, Bolvangar is run like a benign children's centre, complete with scheduled activities for its captured children, who are suspicious but generally compliant. At Bolvangar, Lyra locates Roger and devises a plan for all of the children to escape, knowing through the alethiometer that the Gyptian-led rescue party is still on its way. Mrs Coulter arrives, evidently as a supervisor to the facility, just as Lyra is caught spying by staff-members. The staff decide to silence Lyra through intercision, involving their newly developed dæmon-cutting guillotine; however, she is rescued at the last moment by Mrs Coulter who is shocked by her presence. Mrs Coulter then tries to coax the alethiometer away from Lyra but Lyra has switched the alethiometer case for a decoy, distracting Mrs Coulter long enough to engage the station's emergency alarm. In the ensuing commotion, Lyra sets the station on fire and leads all the children outside where they are met by Lee Scoresby, Iorek Byrnison, the Gyptians, and their new allies, the witch-clan of Serafina Pekkala. Using Lee Scoresby's hot air balloon, Lyra, Roger, and Iorek leave the scene as a battle erupts involving the Gyptians and witches against Bolvangar's mercenary guards and staff members. Lyra befriends Serafina Pekkala and later learns that all of the children have been successfully rescued from Bolvangar.
Determined to deliver the alethiometer to Lord Asriel, Lyra now directs the flying witches to tow the balloon toward Svalbard; however, Lyra falls out of the basket near Svalbard and is quickly taken prisoner by the panserbjørne in their castle. Although captive, Lyra is able to trick their usurping bear-king, Iofur Raknison, into agreeing to fight Iorek, by claiming that she is Iorek's dæmon, and that if Iofur killed Iorek, then she would become Iofur's dæmon—something no bear has and Iofur wants more than anything. Arriving at the castle to rescue Lyra, Iorek successfully kills Iofur in the fight and thus is made king himself. Lyra—now nicknamed "Lyra Silvertongue" by Iorek as a token of her ability to lie — travels onward to Lord Asriel's house of exile, accompanied by Iorek and Roger.
Despite being exiled, Lord Asriel is so influential that he has accumulated all the necessary equipment to continue his research on Dust. He explains to Lyra all he knows of Dust, including the Church's view that it is deeply sinful, his belief that Dust is somehow related to the source of all death and misery, the existence of parallel universes from which Dust originates, and his final goal: he intends to visit the other universes, find the source of Dust (and, therefore, the source of all death and misery), and ultimately destroy it, triumphantly claiming that "Death is going to die". As Lyra sleeps, Asriel leaves to fulfill his great experiment, bringing along his scientific equipment and taking Roger by force. Lyra awakes and pursues them, discovering that she has indeed brought her father what he wanted, though not in the way she thought; it was not the alethiometer he needed, but rather, it was Roger. The severing of a child's dæmon releases an enormous amount of energy, which is precisely what Lord Asriel needs to complete his task. Lyra is unable to save Roger in time though, and his death provides sufficient energy to tear a hole through the northern lights into a parallel universe, ripping the sky apart. Lord Asriel and Mrs Coulter (who catches up with him by zeppelin) face the newly revealed world and romantically embrace, but Mrs Coulter feels unable to go with Asriel and painfully declines his invitation. Without further comment, Lord Asriel walks into the new universe alone and Mrs Coulter returns the way she came. Devastated at her part in rescuing Roger only to bring him to his death, Lyra decides that Dust, contrary to what all the vicious, dishonest adults in her life have told her, may be a force of good rather than evil. She and her dæmon Pantalaimon vow to discover if this is true and to stop Asriel. They then follow him through the opening in the sky.
This concludes the first novel, with the trilogy continuing in the next book, The Subtle Knife.