The Appeals Court ruled 2-1 that Pinochet, 85, suffers from such severe dementia that he cannot be prosecuted on charges of covering up 75 murders by a notorious "Caravan of Death," an army hit squad that toured northern Chile by helicopter eliminating his political foes after Pinochet ousted Marxist President Salvador Allende in 1973.
Prosecution lawyers said they would seek a reversal of the ruling.
"This ruling is the result of political pressures over the court," said lawyer Eduardo Contreras.
"But Pinochet will still go into history as having been indicted on human rights charges," Contreras said. "The trial was only suspended because he is allegedly ill or crazy."
The trial against Pinochet could theoretically resume if the general's health improves. But that possibility is considered remote.
"Court rulings are to be respected, not to be commented (on)," said President Ricardo Lagos. "The government is not satisfied or unsatisfied."
Pinochet suffers from high blood pressure, diabetes and arthritis, has a pacemaker and has had at least three mild strokes since 1998, according to his doctors.
Pinochet, who ruled until 1990, has denied responsibility for the deaths.
Chilean law only exempts from penal responsibility those pronounced mad or demented, but Pinochet's lawyers insisted that the retired general's deteriorated health prevents him from properly organizing his defense, thus depriving him of his constitutional right to a just trial.
"This is disappointing indeed but Pinochet will remain in history as having been spared from trial because he is crazy," said Carmen Hertz, another prosecutor lawyer.
Pinochet spent six ways hospitalized last week and underwent dental surgery and other treatment for high blood pressure. He remains at home under a treatment doctors described as similar to the one at the hospital.
The former dictator was kept under house arrest in London for 16 months at the request of a Spanish judge wanting to try him, but Britain released him on health grounds. He returned to Chile in March last year to continue his long battle in court at home.
"This is not time for celebrations. We have to take seriously my general's health problems," said retired Gen. Luis Cortes, a close Pinochet associate.
Pinochet's older son, also named Augusto, said the family reacted "with calm and satisfaction."
Prosecutors and Pinochet's critics reacted angrily.
"This is frustrating," said Mireya Garcia, vice president of an organization of relatives of dissidents who disappeared after arrests during Pinochet's rule.
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