Insulting Islam's prophet is punishable by death under Pakistani law, and blasphemy accusations stir such emotions that they are nearly impossible to defend against.
The woman alleged that in the row which followed, they said Asia Bibi should convert to Islam, and that she made three offensive comments about the Prophet Muhammad in response.
Pakistani Christian woman Asia Bibi in an undated photo handed out by family in 2010. The judgement of the high court as well as trial court is reversed.
Pakistan's 295-C blasphemy law is based on sharia (Islamic law) which mandates execution for those found guilty of committing blasphemy against Mohammed.
A journalist who visited her in prison before the verdict said she appeared to have memory loss and confusion.
Her case has outraged Christians worldwide and been a source of division within Pakistan, where two politicians who sought to help Bibi were assassinated.
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Bibi's legal team celebrated the court's decision amid beefed-up security in Islamabad after religious hardliners had vowed to protest any acquittal of the case. The two Muslim women who pressed charges against Bibi denied they quarreled with her, saying her outbursts against Islam were unprovoked.
In February, Ms. Bibi's husband Ashiq Masih and one of her daughters met with Pope Francis shortly before Rome's ancient Colosseum was lit in red one evening in solidarity with persecuted Christians, and Ms. Bibi in particular.
To this, Justice Khosa had remarked, "From your statements we have gathered that the Imam himself did not witness the incident as it happened and no blasphemous words were said in his presence".
The Supreme Court has banned local media from reporting on the case until the judgement is announced. The Lahore High Court (LHC) had upheld her conviction and confirmed her death sentence in October 2014.
Islamists have demanded her execution.
Bibi's supporters maintain her innocence and insist it was a personal dispute, and the Vatican has called for her release. In 2011, Salman Taseer, the governor of Punjab province was shot and killed by one of his elite guards for defending Bibi and criticizing misuse of the blasphemy law. The assassin, Mumtaz Qadri, has been celebrated as a martyr by hard-liners since he was hanged for the killing, with millions visiting a shrine set up for him near Islamabad.