Pakistan released a CIA worker accused of murdering two civilians after the US paid more than two million dollars to the men's families.
The case against Raymond Allen Davis, who claims he shot the pair in self-defence, was dropped after the "blood money" payment.
The killings and his arrest had strained ties between Pakistan and the US and added to anti-America sentiment.
Punjab Law Minister Rana Sanaullah said Davis was charged with murder today but then immediately pardoned by the families of the victims in exchange for compensation as is permitted under Pakistani law.
Washington insisted Davis, on contract to the CIA, was acting in self-defence against robbers when he shot the men while driving through Lahore on January 27.
Some reports claimed they were members of Pakistan's Inter Services Intelligence agency.
The US had insisted that Davis had diplomatic immunity and demanded Pakistan free him immediately.
Pakistani officials, faced with criticism by Islamist parties and members of the public, had refused to state clearly whether he had immunity.
Pakistani officials had suggested that the payment of "blood money" was the best solution and in recent days speculation mounted that such a deal was in the works.
Mr Sanaullah said Davis was charged with murder before members of the dead mens' families were taken into the court, where they signed papers formally forgiving him in exchange for £2.3 million dollars.
Judges then acquitted him on all charges.