Fujimoto, a once-human wizard/scientist, lives underwater along with his daughter, Brunhilde, and her numerous smaller sisters. While she and her siblings are on an outing with their father in his four-flippered submarine, Brunhilde sneaks off and floats away on the back of a jellyfish. After an encounter with a fishing trawler, she becomes trapped in a glass jar and drifts to the shore of a small fishing town where she is rescued by a five-year-old boy named Sōsuke. Shattering the jar with a rock, Sōsuke cuts his finger in the process. Brunhilde licks his wound causing it to heal almost instantly. Sōsuke names her Ponyo and promises to protect her. Meanwhile, a distraught Fujimoto searches frantically for his lost daughter whom he believes to have been kidnapped. He calls his wave spirits to recover her, leaving Sōsuke heartbroken and confused by what happened.
Ponyo and Fujimoto have an argument, during which Ponyo refuses to let her father call her by her birth name. She declares her desire to be known as ‘Ponyo’ and to become human. Using her magic, she forces herself to grow leg- and arm-like appendages and start changing into a human, a power granted to her by the human blood she ingested when she licked Sōsuke’s finger. Her alarmed father forces her to change back into her true form and leaves to summon Ponyo’s mother, Gran Mamare. Meanwhile, Ponyo, with the help of her sisters, breaks away from her father and inadvertently uses his magic to make herself fully human. The huge amount of magic that she releases into the ocean causes an imbalance in the world, resulting in a tsunami, leaving ships stranded at sea. Ponyo goes back to Sōsuke, who is amazed and overjoyed to see her. He tells his mother, Lisa, that Ponyo has returned as a little girl. Lisa allows Ponyo to stay at their house for the time being, and they wait out the storm together at Sōsuke’s house. Worried about the residents of the nursing home where she works, Lisa leaves to check up on them, promising Sōsuke that she will return home as soon as possible.
Gran Mamare arrives at Fujimoto’s submarine. Sōsuke’s father, Kōichi, sees her traveling and recognizes her as the Goddess of Mercy. Fujimoto notices the moon appears to be falling out of its orbit and satellites are falling like shooting stars, symptoms of the dangerous imbalance of nature that now exists. Gran Mamare declares that if Sōsuke can pass a test, Ponyo can live as a human and that the order of the world will be restored. A still-worried Fujimoto reminds her that if Sōsuke fails the test, Ponyo will turn into sea foam.
Sōsuke and Ponyo wake up to find that most of the land around the house has been covered by the ocean. Since it is impossible for Lisa to come home, the two children decide to find her. With the help of Ponyo’s magic, they make Sōsuke’s toy pop pop boat life-size and set out across the swollen ocean.
When Ponyo and Sōsuke make it to the forest, however, Ponyo tires and falls asleep only to be woken by Sōsuke, who implores her to ignite a second candle as the one powering their boat is about to go out. Ponyo then dozes off multiple times before concentrating enough to make the candle, which then goes out. She then passes out, and Sōsuke has to push the boat to shore, only to find that the boat is reverting to its toy size. Sōsuke drags Ponyo to the shore, where he finds Lisa’s abandoned car. Ponyo then wakes up, and the two decide to continue looking for her.
Ponyo and Sōsuke head into a tunnel, where Ponyo mysteriously reverts to her fish form. Meanwhile, Lisa and the residents of the nursing home, who are temporarily able to breathe water because of Gran Mamare, are waiting excitedly below the surface for Ponyo and Sōsuke to arrive. Sōsuke and Ponyo encounter Fujimoto, who warns the boy that the balance of nature is in danger and begs Sosuke to return Ponyo to him. Sōsuke doubts Fujimoto and attempts to flee, but the two children are quickly captured and Fujimoto takes them down to the protected nursing home.
Sōsuke is reunited with Lisa and meets Gran Mamare, with whom Lisa has just had a long private conversation. Gran Mamare asks Sōsuke if he can love Ponyo whether she is a fish or human. Sōsuke replies that he “loves all the Ponyos.” Gran Mamare then tells her daughter that if she chooses to become human once and for all, she will have to give up her magical powers. Ponyo agrees to this, so Gran Mamare encases her in a bubble and gives her to Sōsuke. She tells him that kissing the bubble will complete Ponyo’s transformation. The balance of nature is thus restored and the previously stranded ships head back to port. Fujimoto respects his daughter’s choice to become a human, having decided he can trust Sōsuke. Ponyo then joyfully jumps high in the air and kisses Sōsuke, completing her transformation as a human.