"The government will formally withdraw the bill in order to fully allay public concerns," Lam said in a video statement released via her office.
Millions of people have taken to Hong Kong's streets since June in the biggest challenge to China's rule of semi-autonomous Hong Kong since its handover from the British in 1997.
After refusing for months to withdraw the bill, which aimed to allow extraditions of criminal suspects to mainland China, Lam finally conceded as she called for calm.
Initial reports in the local media flagging Lam's announcement raised hopes that giving in to the extradition demand could help end the crisis.
But those hopes were quickly tempered, with pro-democracy activists voicing anger and determination to press on with their broader democracy campaign.
"Too little, too late," said Joshua Wong, a prominent activist who was arrested late last week as part of a police swoop of leading pro-democracy figures.
"We urge the world too to (be) alert this tactic and not to be deceived by HK and Beijing Govt. They have conceded nothing in fact, and a full-scale clampdown is on the way."
Initial response to Carrie Lam:Joshua Wong 黃之鋒 (@joshuawongcf) September 4, 2019
1. Too little and too late now — Carrie Lam's response comes after 7 lives sacrificed, more than 1,200 protestors arrested, in which many are mistreated in police station.
The protests began as opposition to efforts by Lam's government to introduce the extradition legislation, which was seen as another erosion of the liberties enjoyed in Hong Kong compared with in mainland China.
After millions of people took to the streets, Lam suspended efforts to have the legislation passed but infuriated protesters by repeatedly refusing to formally withdraw it.
The movement also evolved into a much broader campaign to include demands for an independent inquiry into alleged police brutality against the protesters, and an amnesty for those arrested.
Another demand was for Hong Kongers to be able to directly elect their leaders -- a major red line for Beijing.
Online message forums used by the largely leaderless democracy movement were on Wednesday filled with angry comments saying bill's withdrawal would not end the protests.
"More than 1,000 people have been arrested, countless injured," one widely shared message on the Telegram messaging app read.
"Five major demands, not one less. Liberate HK, revolution now," it added.
For much of the past three months Lam has struck a defiant tone, appearing either unwilling or unable to make any concessions.
Then an audio recording emerged this week of her telling business leaders she revealed the influence of Beijing, which viewed the protests as a national security and sovereignty issue.
In the audio recording, Lam said she wanted to quit and take responsibility for triggering the unrest with the extradition plans, but that she was hamstrung by Beijing.
"For a chief executive to have caused this huge havoc to Hong Kong is unforgivable," an emotional Lam said in the audio recording, which was obtained by the Reuters news agency.
"If I have a choice," she said, speaking in English, "the first thing is to quit, having made a deep apology."
But after the audio recording was released, Lam held a press conference on Tuesday to insist she had never contemplated resigning.