Only 51 of more than 1,100 juveniles caught with an offensive weapon were locked up this spring, half as many as a year earlier.
Among all offenders, more walked free with suspended sentences and fewer were sent straight to prison despite judges being under orders to take the crimes seriously.
It means Chris Grayling, the Tory "attack dog" who replaced the more liberal Kenneth Clarke at the head of the Ministry of Justice in this week's reshuffle, will face calls to make sentences tougher.
In opposition, Mr Grayling said he wanted a "zero-tolerance" approach to people carrying knives and said they should be put "behind bars" rather than "getting off with a caution".
The quarterly knife possession sentencing report, published by the MoJ on Thursday, shows that overall there has been a sharp fall in the number of cases being dealt with by police and courts.
In total 4,270 offences of possession of a bladed article or offensive weapon were handled between April and June this year, compared with 5,194 for the same period in 2011.
But a smaller proportion (22 per cent) led to immediate custody than a year ago (24 per cent) while more led to suspended sentences (13 per cent compared with 11 per cent).
The proportion of cases resulting in community punishment fell slightly (to 28 per cent from 30 per cent) as did those leading to cautions, which do not count as criminal convictions but which are recorded on police computers.
In total there were just 530 people in jail for carrying a knife on June 29th this year, down 5 per cent on the previous year.
Among under-18s the drop in those being locked up was even greater between the second quarter of 2011 and the same period in 2012.
The proportion of juveniles being let off with a reprimand or a warning rose from 30 to 31 per cent over the past year, while 56 per cent were given community sentences.
"This was balanced by a decrease in the proportion receiving immediate custodial sentences from 11 per cent (112) to 7 per cent (51)."
The MoJ's own report noted that judges have been told by the Court of Appeal and the Sentencing Guidelines Council to take knife possession seriously.
Magistrates have been told to sentence offenders "at the top end of the range" while the starting point for the "lowest level" among adults is supposed to be 12 weeks' custody.
A spokesman for the Ministry of Justice said: "The number of people found in possession of a knife has fallen substantially this year when compared with the same period in 2011.
"Also, those convicted and sentenced to prison for knife possession are receiving longer sentences compared to a year ago.
"Any adult who commits a crime using a knife can expect to be sent to prison and serious offenders can expect a long sentence."
Asked if David Cameron was concerned that the proportion of people who were jailed for carrying a knife had fallen, the Prime Minister's official spokesman said: "Sentencing in individual cases is for the courts."