Batty's agent Hayden Evans said: "David was asked into a meeting and told of the decision. As you can understand, he is extremely disappointed."
He was a member of Howard Wilkinson's title-winning side during his first spell at Leeds and became David O'Leary's first signing as Leeds manager in December 1998 when he paid Newcastle £4.4m for him to return to Elland Road.
O'Leary's successor Terry Venables froze Batty out of the first team, but he was recalled by Peter Reid and featured under Gray when he opted for a five-man midfield.
He started his career with Leeds back in 1987 and made more than 250 appearances for his hometown club before leaving to join Blackburn Rovers in October 1993, where he also won a championship medal.
In March 1996 he moved onto Newcastle, spending two and a half years on Tyneside.
He was also capped 42 times for England. The decision could infuriate fans, who have always treated Batty as one of their own and whose experience could have been crucial in the relegation dog-fight.
However, Gray said: "I'll accept any criticism because the supporters pay their entrance fee.
"I've made a decision that I will not be using David again this season, purely from a footballing point of view. I feel it is the right decision.
"I had a chat to David this morning and he knows how I feel. I think we can cope without him, but time will tell.
"He was okay, and although I don't expect him to be happy, I've got to look at the overall picture. We played 4-4-2 on Saturday and that's the way we will play between now and the end of the season.
"We've got to try to win as many matches as we can and that's the way we will do it. It's one of the things I spoke to David about. But it's been frustrating for him as well, especially in the last four to five weeks. I've told David what I thought and we'll leave it at that."