A spokesman for the City of London Police said: "A 26-year-old woman from South London was arrested on Monday on suspicion of sexual assault on a child.
"She has since been bailed, and enquiries continue."
The City of London School for Girls was founded in 1894 and now has around 670 pupils aged from five to 18.
Parents of all children at the school were sent text messages warning them about the incident, which involved a 26-year-old teacher.
A letter by Diana Vernon, headmistress at the £13,000-a-year school, described the matter as an "inappropriate relationship".
Police arrested the teacher on Monday after Miss Vernon alerted officers.
In the letter addressed to parents, Miss Vernon said: "I am contacting you to inform you that a member of staff has been arrested following investigations, conducted by the City of London Police, into an alleged, inappropriate relationship with one of our students.
"The member of staff concerned has been put under precautionary suspension from duty, pending further enquiries.
"The school takes its responsibilities for the safeguarding of children extremely seriously; we were proactive in reporting this allegation and have since been co-operating fully with the police and other authorities.
"As always, the well being of our students is our paramount concern."