U.S. District Magistrate Judge Candy Wagahoff Dale issued the ruling in Boise hours after a morning hearing.
WildEarth Guardians and other environmental groups had sought to stop the derby, arguing the Forest Service was ignoring its own rules that require permits for competitive events.
The agency, meanwhile, countered no permit was needed, concluding while hunting would take place in the forest on Saturday and Sunday, the competitive portion of the event — where judges determine the $1,000 prize winner for the biggest wolf killed — would take place on private land.
Dale decided derby promoters were encouraging use of the forest for a lawful activity.
"The derby hunt is not like a foot race or ski race, where organizers would require the use of a loop or track for all participants to race upon," she wrote, of events that might require such permits. "Rather, hunters will be dispersed throughout the forest, hunting at their own pace and in their own preferred territory, and not in a prescribed location within a designated perimeter."
Steve Alder, an organizer of Idaho's derby, said dozens of people had already arrived in Salmon to participate. He was elated following the decision.
"We won," Alder said. "You've got a lot of people who have driven from far distances to Salmon, today. A lot of motels have a lot of occupants; a lot of money has been expended for this event. It's good for Salmon, but I don't want to send them packing home."
Every year, predator derbies are staged across the West and much of the rest of the country, where hunters compete to bag the most coyote, fox and other animals.
But wolves — and the notion that hundreds of armed sportsmen might head to the hills to shoot at them for cash — captured the passions of wildlife advocates on a landscape scale after they learned of the Idaho derby.
It's been just two years since Endangered Species Act protections were lifted, and WildEarth Guardians executive director John Hornung said many people believe the big carnivores still face existential threats that are compounded when they're hunted for prizes.
"To go from that position a mere two years ago, to contest hunts, is just incredibly dissonant to groups like ours, and I think, a lot of the public. It just doesn't make sense," Hornung said from his office in Santa Fe, N.M., adding he believes contest hunts are "all about a scorched earth approach to these native carnivores."
In Friday's telephone hearing, WildEarth Guardians' attorney told Dale that a wolf derby taking place on Forest Service land that surrounds Salmon should be required to get the same kind of special permit as any other competitive gathering, including running races or snowmobile events.
"People are trying to kill as many animals as they can in two days in order to win the prize," Sarah McMillan told the judge.
Meanwhile, attorneys for the U.S. Forest Service countered that no permit was needed.
Assistant U.S. Attorney Joshua Hurwit also said hunters could be in the woods and fields near Salmon this weekend shooting wolves and coyotes — regardless of whether their excursions were associated with a contest.
"There's nothing to stop people who intended to participate in the derby, from going forward and taking the same action, killing coyotes and wolves, and just not participating in the derby," Hurwit told Dale. "The derby doesn't change hunting, hunting will happen throughout the season regardless of this lawsuit. The derby hunters will have to comply with state regulations."
Wolves became big game animals in Idaho, Montana and Wyoming after federal Endangered Species Act protections were lifted starting in 2011. There are annual hunting and trapping seasons.
After reintroduction in the state in the mid-1990s, Idaho has about 680 wolves, according to 2012 estimates.