She has reportedly forged an alliance between her conservative CDU party and the centre left SPD – ending months of political limbo and staving off the prospect of a new general election.
But the coalition will still have to be approved by the titans of both parties.
And, as part of the deal, Mrs Merkel has been forced to give in to europhile SPD leader Martin Schulz’s demands for a huge cash windfall to the European Union to help prop up the Eurozone.
According to Reuters, the agreement will see the government “commit to strengthening the Eurozone in close partnership with France”.
The report added: “Parties support devoting specific budget funds for economic stabilisation, social convergence and structural reform support in the Eurozone.”
It adds the parties will commit to developing “common positions with France on all important questions of European and international politics”.
And last month Mr Schulz said he wanted a United States of Europe with eight years.
He told party delegates in December: “I want there to be a constitutional treaty to create a federal Europe.”
The former EU president added: “The SPD is needed for a just and innovative Europe.
“Our country cannot afford another four years of European policy à la [former conservative Finance Minister] Wolfgang Schäuble.”
French leader Emmanuel Macron has also called for an EU army and shared defence budget in a bold vision for Europe.
He has also demanded a eurozone budget and a finance minister. These initiatives will now surely be backed by the German coalition giving more power to a France and Germany powered Brussels.
The SPD will vote on any final deal at a party congress for January 21.
Then, if the broad outline for a government is approved, more political horse trading will ensue to decide who gets what ministry, taxation, health and environmental issue.
The business bible Handelsblatt reported: “The last exploratory round of talks took more than 24 hours, but now an end is on the way. The party leaders of the Union and the SPD have apparently agreed on contentious issues in financial and refugee policy.”
The talks were held at Willy Brandt House in Berlin, the SPD party HQ. By dawn on Friday both sides were still haggling over the details of power sharing.
"It is progressing in mini-steps, but it is still tough," said the Bild newspaper website.
Mrs Merkel’s allies in Bavaria, the Christian Social Union, were said to be talking through the night and holding up a final agreement.
“The CSU is holding up everything,” said one SPD negotiator. “Otherwise we would have had a deal sooner.”
The SPD ruled in coalition with Mrs Merkel for the past four years but was heavily punished by voters in last autumn’s poll, causing party leader Mr Schulz to declare it would serve the public better to Benin opposition.