In their joint blueprint, the parties agreed on key policy outlines - to join European Union partner France in a push to "strengthen and reform" the eurozone, to limit the influx of asylum seekers to Germany to around 200,000 a year, and to refrain from tax hikes given the healthy state of public coffers.
On the thorny issue of family reunions for asylum seekers granted temporary refuge, the preliminary accord says current restrictions should be loosened.
According to a coalition paper leaked to German press on Friday morning, the new government would be prepared to make higher contributions to the European Union budget, as well as support "funds for economic convergence and social convergence and support of structural reforms that can be starting point for future investment budget for eurozone". The influx drove the rise of the far-right Alternative for Germany party which scored nearly 13 pc in September elections.
Weakened by an election setback in September, Mrs Merkel turned to the left-leaning SPD to renew their grand coalition after the collapse in November of talks on a three-way coalition with the Greens and Free Democrats (FDP).
The German parties' glacial place in setting up a new administration is testing the patience of voters who gave Merkel's Christian Democratic-led bloc the most votes in the September 24 contest. But to make a new government a reality, he must first persuade a party congress January 21 to agree to hold formal coalition negotiations.
After the week of negotiations and the overnight session, a visibly exhausted Merkel told reporters that she, too, was now "optimistic that things will move forward" to forming a new coalition of the same parties that have run Germany for the past four years.
In the early stages of exploratory talks this week, it was reported that Germany's would-be coalition partners had agreed to drop plans to lower carbon dioxide emissions by 40% from 1990 levels by 2020.
However, SPD chief Martin Schulz, who had also initially ruled out governing under Merkel, praised the deal Friday and said the party leadership had unanimously backed the coalition blueprint.
The parties pledged to fight tax dumping and evasion in Europe, pushing for "fair taxation of big companies" including internet giants Google, Apple, Facebook and Amazon, and called for unspecified minimum rates for corporate tax. According to the German media, the three parties agreed not to raise taxes if they form a governing alliance, and to increase Germany's input to the European Union budget.
Merkel now leads a caretaker government, limiting her ability to take major policy initiatives as French President Emmanuel Macron pushes an ambitious European reform agenda.
"In the long time since the elections, we have seen that the world is not waiting for us", Merkel told reporters on Friday. "We are convinced that we need a new awakening for Europe".
Jean-Claude Juncker, European Commission president, hailed the parties' plans for Europe's future as "very significant" and "positive".
The party leaders agreed to a 28-page deal on Friday morning. Another lawmaker, Frank Schwabe, described the deal on migrant's relatives as "shabby".