Cancelo joined the Premier League champions from Juventus in the summer of 2019 for £60m and his previous deal would have expired in 2025.
The 27-year-old’s new deal will see him remain at the Etihad Stadium until the summer of 2027.
Cancelo has made 106 appearances for Pep Guardiola’s side and has a Premier League winner’s medal in his time at the club.
The Portugal international has made 30 appearances across all competitions this season, scoring three goals and providing eight assists.
'Manchester City is a fantastic club, so I am incredibly happy to have signed this new agreement,’ Cancelo told Man City’s official website.
'City players have everything they need to reach their full potential, with amazing facilities, world-class team-mates and an incredible manager who pushes us every single day.
'There is nowhere better to play football and it's a pleasure to work here. I have so much I want to achieve before my career ends, and Manchester City offers me the best chance of fulfilling my ambitions.
'This new contract means I now have complete focus on improving my game and winning more trophies with this team.'
City's director of football Txiki Begiristain added: 'Joao is the ultimate professional. He absolutely loves football and applies himself every single day in a bid to become better.
'He sets really high standards, and any young player should observe the way Joao applies himself if they want a blueprint for success.
'Not only does he have incredible talent, he also displays perfect dedication to this sport. That's why he can play so many games at such a high level. His consistency during the last two seasons has been amazing.
'He is so versatile. Whether he plays right-back, left-back or in midfield, he operates at the same high level. That is a dream for a manager.
'I am really happy he has signed, and I can't wait to see him develop in the coming years.'
