Saints had imposed the sanction following trouble with Celtic fans at their previous away game against Motherwell on December 6.
That night smoke bombs were let off and flares thrown onto the pitch at the away end of Fir Park, where over 200 seats were also damaged, and the ban was introduced in a bid to prevent fans using flags to hide the use of pyrotechnics.
Celtic caused confusion on Monday when they released a statement claiming the ban on favours was 'now lifted', a statement which Police Scotland denied, but now St Johnstone have confirmed Police have sanctioned a relaxation for the Perth showdown.
A statement on Saints' website read: "Further discussion has today taken place between all parties and a request from the clubs made to Police Scotland that the ban be lifted has been accepted.
"Safety remains of paramount importance to both clubs and the match will be managed with this in mind.
"With Police Scotland having reviewed this policy, the two clubs are now putting their faith in all supporters that they shall support their respective teams in a manner which befits what should be a great game of football on a special date in the football calendar."
Celtic admitted they had jumped the gun with their statement on Monday but they welcomed the confirmation of the decision.
In a statement of their own, they said: "For clarity, Celtic Football Club has received confirmation that flags and banners will now be permitted at the match against St Johnstone on Boxing Day.
"Last week, Celtic Football Club noted the advice given by local police regarding safety, flags and banners at the match.
"We acknowledge we had not received final confirmation yesterday in terms of a change. However, we are pleased, following consultation and discussion over the past couple of days, that the initial decision has been reviewed by the police and St Johnstone FC."