The novel is set in a world dominated by an international theocracy, the Magisterium (also commonly called "the Church"), which actively suppresses heresy. In this world, humans' souls naturally exist outside of their bodies in the form of sentient "dæmons", talking animal spirits that constantly accompany, aid, and comfort their humans. Children's dæmons can freely and instantaneously change their appearance into that of any real or mythical creature; once people reach puberty, however, their dæmons settle into one permanent form.
Twelve-year-old Lyra Belacqua runs wild with her dæmon Pantalaimon around Jordan College, Oxford, under the guardianship of the college's Master. One day, she witnesses the Master poison wine intended for Lord Asriel, Lyra's rebellious and adventuring uncle. She warns Asriel not to drink the wine, then spies on his lecture about "Dust", mysterious elementary particles attracted to adults more than children. Asriel shows the college scholars images of a parallel universe seen through the Northern Lights amidst a concentration of Dust. The scholars agree to fund his controversial research, which is considered heretical by the oppressive Church.
Lyra's best friend Roger goes missing, presumed kidnapped by mysterious child abductors called "Gobblers". Mrs Coulter, a charming socialite, adopts Lyra. Before Lyra leaves Jordan, the Master secretly entrusts her with an alethiometer, a strange truth-telling device, which she quickly learns to use intuitively. After several weeks, Lyra discovers that Coulter is the head of the Gobblers, or "General Oblation Board", a secret Church-funded project. Horrified, Lyra flees to the Gyptians, canal-faring nomads, many of whose children have also been abducted. They reveal to Lyra that Asriel and Coulter are her parents.
The Gyptians form an expedition to the Arctic with Lyra, where they believe the Gobblers are holding their children. They stop in Trollesund, where Lyra meets Iorek Byrnison, the dispossessed royal heir of the panserbjørne (armoured bears). Lyra uses her alethiometer to locate Iorek's missing armour; in return, he and his human aeronaut friend, Lee Scoresby, join her group. She also learns that Lord Asriel has been exiled, guarded by the panserbjørne on Svalbard. Trollesund's witch consul tells the Gyptians of a prophecy about Lyra which she must not know, and that the witch clans are choosing sides for an upcoming war.
The search party continues towards Bolvangar, the Gobbler research station. Guided by the alethiometer, Lyra detours at a village and discovers an abandoned child who has been cut from his dæmon and who soon dies. She realises the Gobblers are experimenting on children by severing the bond between human and dæmon, a soul-splitting process called intercision. Lyra and her companions are attacked by bounty hunters, and Lyra is captured and taken to Bolvangar, where she is briefly reunited with Roger before being sent to be separated from Pantalaimon. Just before this can occur, Coulter arrives and halts the intercision process. She tells Lyra that intercision prevents the onset of troubling adult emotions, though it has not yet been perfected.
Lyra activates Bolvangar's emergency alarm, sets the station on fire, and evacuates the children, where they are rescued by Scoresby, Iorek, the Gyptians, and the witch clan of Serafina Pekkala, who battle the station attendants as Lyra, Roger, and Iorek flee in Scoresby's hot air balloon. Lyra directs the witches to tow the balloon towards Asriel in Svalbard, but she falls out and is taken by the panserbjørne to the castle of their usurping king, Iofur Raknison. She tricks Iofur into fighting Iorek, who arrives with the others to rescue Lyra. Iorek kills Iofur and regains his place as the rightful king.
Lyra, Iorek, and Roger continue onwards to Svalbard, where Asriel has continued his Dust research in exile. He tells Lyra all he knows of Dust: that it has spawned parallel universes, it is somehow connected to death and misery, and that the Church believes it is the physical basis of sin. He plans to visit the other universes and destroy the source of Dust. Suddenly, he severs Roger from his dæmon, killing Roger but releasing an enormous amount of energy that tears a hole in the Northern Lights to a parallel universe, through which he walks. Because Asriel believes Dust is a force of evil, the devastated Lyra decides that perhaps it is really a force of good. Vowing to stop her father, she and Pantalaimon pass through the opening in the sky.