Dagg sustained the problem during the Super Rugby season, forcing him to miss several weeks of the Canterbury Crusaders' march to an eighth title but had returned for the All Blacks.
He missed the first two Rugby Championship matches against Australia due to the injury but started against Argentina earlier this month in New Plymouth before it flared up again.
He was not considered for the All Blacks' 57-0 demolition of South Africa on Saturday and coach Steve Hansen said last week the prognosis did not look good for the 66-test veteran to return this year.
"Izzy Dagg will rest and rehab his knee for the rest of the year..." the All Blacks said on their verified Twitter account on Friday. "No need for surgery."
Dagg's absence should see a prolonged stay in the New Zealand number 15 jersey for Damian McKenzie, with regular fullback Ben Smith on a sabbatical and rookie Jordie Barrett ruled out with a shoulder surgery.
Hansen has added David Havili to the Rugby Championship squad and the uncapped back could get a run in the All Blacks' final two games, against Argentina next week and South Africa on Oct. 7.
Flyhalf Beauden Barrett, who spent the first four years of his All Blacks career as an impact substitute, filling the fullback or flyhalf position from the bench, could also slot in at number 15.
Barrett was a late call-up for the squad to travel to Argentina after Lima Sopoaga opted to remain at home to await the birth of his first child. Barrett had originally been rested with plans to join the team later in South Africa.
The 26-year-old Barrett is currently the only specialist flyhalf in the squad for the Pumas test, although Hansen has said previously he saw McKenzie's future in the pivotal role.
(Reporting by Greg Stutchbury; Editing by John O'Brien)
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