The deal, under which the two partners will share what they considered as the most crucial ministries for themselves, will however to be approved by SPD members in the coming weeks.
The agreement could bring an end to months of uncertainty in Europe's dominant power and biggest economy.
Negotiators have been in non-stop talks since Tuesday morning. And though the SPD secured a number of important positions in the next Cabinet during negotiations, such as the finance and foreign affairs ministries, there's no guarantee that it will vote in favor of the agreement.
Those opposed to any deal with Mrs Merkel include a new group within the SPD calling itself NoGroKo (no grand coalition).
According to the coalition pact, Germany will aim to limit the annual intake of people seeking safe haven to around 200,000, in line with a long-standing demand of the CSU.
German media said Merkel's Christian Democrats will fill the defense and economy posts, and the CDU's Bavarian sister party will get the Interior Ministry.
But debates at European Union level are likely to still depend on priorities and personalities within the grand coalition's parties.
But he changed his mind when CDU/CSU coalition talks with the liberal Free Democrats (FDP) and Greens broke down.
Another alliance between Merkel's Christian Democratic-led bloc and the SPD, a "grand coalition" between the two biggest parties, appeared nearly impossible after the September 24 election, when the SPD suffered its worst defeat since World War II.
Separately, French Finance Minister Bruno Le Maire told Reuters the European Union must lead the way by adopting legislation early next year to ensure that big global tech companies pay billions of euros in taxes in Europe. She could have headed a minority government, which she didn't want, and a snap election risked boosting the far-right Alternative for Germany.
Handing Germany's centre-left control of finance, foreign and labour policy would have a big impact on the rest of the world, particularly Europe.
"Regardless of whether a ministry is led by the Social Democrats or the (Christian Democratic) Union, you can only spend the money you have", Merkel said.
After more than 24 hours of talks at the CDU's headquarters, Merkel headed home for a few hours rest before a planned press conference to outline details of the deal.
An agreement which looks like a win for the SPD will increase the likelihood that they will vote yes. The most likely outcome would be fresh elections, which would mean no permanent government until autumn - a whole year after the first set of elections.
What has the reaction been?
That the division of cabinet responsibilities resembles that of Mrs Merkel's first government from 2005, when unlike now the SPD had nearly as many MPs as the CDU/CSU, speaks to the scale of the concession.
Senior EU officials welcomed the announcement, with Pierre Moscovici tweeted it was good news for Europe.
A recent Insa poll found that support for the CDU/CSU had fallen from 33% to 30.5%, while the SPD slipped from September's historic low of 20.5% to 17%.
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