Red Army Faction leader Christian Klar, aged 56, is serving five life terms but will have served the minimum required 26 years by January.
The court in Stuttgart said there were no grounds to keep him in custody.
The group, also known as the Baader-Meinhof gang, targeted bankers, businessmen, judges and US servicemen.
"A major consideration was the question of whether it could be feared that Christian Klar would commit significant criminal acts again," but the judges decided there was no evidence he would, the court said in a statement.
Also see baader-meinhof.com; "It wasn't just about killing Americans, and killing pigs, at least not at first. It was about attacking the illegitimate state that these pawns served. It was about scraping the bucolic soil and exposing the fascist, Nazi-tainted bedrock that the modern West German state was propped upon. It was about war on the forces of reaction. It was about Revolution."