"A close inspection of the matter has now shown that this claim was not accurate. With an expression of my regret I hereby withdraw it," Heinz-Christian Strache of the Freedom Party (FPÖ) said on Facebook.
Photographer Juerg Christandl, who had sued Strache after he claimed the picture was doctored, said that this meant that "for me, the matter is now closed". He said would not receive any money.
The photo, published in the Kurier daily, was of FPÖ sympathisers holding up signs saying "No to asylum shelter" as a Syrian family with a young child arrived in Vienna in June 2015.
Strache's party, one of several populist parties on the rise across Europe, is leading in opinion polls on the back of unease about the arrival of 90,000
asylum-seekers in Austria last year.
On Sunday, the FPÖ's candidate Norbert Hofer came a clear first in the first round of elections for the largely -- but not entirely -- ceremonial post Austrian president with 35 percent of the vote.
Hofer will now face Alexander van der Bellen, former leader of the Greens, in a run-off on May 22. A Gallup poll released Friday, which surveyed 400 people, put both candidates neck-and-neck.
The first round was a debacle for the two centrist parties in Chancellor Werner Faymann's coalition, which have dominated Austrian politics since 1945, with their candidates knocked out of the race.
This is despite the government taking a harder line on migrants, with parliament this week passing one of Europe's toughest asylum laws and the country tightening border controls.
Hofer predicted on Friday as he presented new campaign posters -- "The RIGHT comes from the PEOPLE", says one -- that he would win "significantly" more than 50 percent on May 22.
The FPÖ has toned down its anti-immigration rhetoric, with Hofer focusing more on issues like direct democracy and opposing a contentious mooted trade deal between Europe and the United States.
But despite coming across as likeable and moderate, Hofer, 45, is nonetheless an important figure in formulating FPÖ party policy who has said Islam "has no place in Austria".
The Oesterreich tabloid described him this week as "a kind, nice protest politician who wraps the FPÖ's brutal declarations against refugees in soft language".