Hafiz Saeed term will be expiring next week.
India accused Pakistan of helping organize the attacks in cooperation with Saeed, who is head of the Jamaat-ud-Dawa (JuD) charity, which USA officials say is a front for the banned Pakistan-based Lashkar-e-Taiba militant group.
While his four aides were set free in the last week of October, Saeed was detained for another month.
A Punjab Home Department official said it is feared the release could invite global sanctions on the country.
The Jamaat-ud-Dawah is believed to be the front organisation for the banned Lashkar-e-Taiba (LeT) which was responsible for carrying out the 2008 Mumbai attack. Subsequently, his house arrest had been extended several times.
The provincial government had asked for another 60-day extension to the cleric's detention, but, during Wednesday's court proceedings, judges turned down the request and ordered that Saeed be freed from his house arrest.
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By late Friday night , a cold front will move through, possibly bringing a few rogue raindrops, mainly to our North Zone. Temperatures will cool down again Wednesday thanks to more clouds with highs returning to the 50s and 60s.
"The court today said that there is nothing against Saeed, therefore he should be released".
Saeed has denied involvement in the attacks. "As his earlier detention for a month (an extended period) is over, it seems he will walk free from house arrest tomorrow (Thursday)", said prosecutor Sattar Sahil.
USA and Indian officials did not immediately comment on the court's order.
The counsel of the federal government argued that the release of four associates of Saeed had created law and order issues. "The government can not afford to set Saeed free in the current circumstances. It can not face worldwide backlash in the event of releasing the JuD chief", an official source told PTI. He argued that there is no proof against him and he had been detained illegally. However, the board rejected the plea to extend his detention on the grounds of insufficient evidences. The government can detain a person for up to three months under different charges but for frequent extensions to that detention, it has to seek the approval of the court.
The United States had offered a $10-million reward for information leading to the arrest and conviction of Saeed and has accused Pakistan of offering a safe haven for insurgents operating in neighboring countries.