In this paper we present a novel displacement sensing system where the sensing direction is in the plane of the planar sensor coils. Particular emphasis in this work is given to the design and micro fabrication of the sensor coils.Preliminary analysis and experiments have been carried out to determine the most suitable geometry and number of turns for the sensor coils. It has been found that the position of the sensor coils is extremely important as the location of the sensor coils relative to the target significantly affects the sensitivity of the resultant sensing system. Extensive experiments have been carried out using a number of different coil geometries with the same signal conditioner in each case. These experiments show that best sensitivity is achieved when the sensor coil is located so that the overlap area between the rotor and the sensor coil turns changes most rapidly with the rotor displacement. Following the preliminary analysis and experiments, new optimized sensor coils have been designed and micro fabricated using UV lithography and electroplating, as detailed in the paper.Performance testing of the resultant sensing system has been carried out and is reported in the paper. In addition, the displacement system has been applied to a micro magnetic bearing system for suspending a micro rotor.