The 52-year-old has lost his job after two-and-a-half years in charge of los Rojillos, with the club losing their first three league fixtures and sitting at the foot of the table
52-year-old Mendilibar took charge in February 2011 following the dismissal of Jose Antonio Camacho and narrowly saved the club from relegation last season.
But three defeats in a row at the start of this term have left los Rojillos rock bottom of the Spanish top flight and seen Mendilibar pay the ultimate price.
Osasuna president Miguel Archanco announced the decision on Tuesday: "We will find a young coach who is committed to using young players."
The club, who are currently in their 14th consecutive season in La Liga, have now announced 43-year-old coach Gracia as the new manager of the Pamplona outfit, and he has signed a two-year deal with Osasuna.