SPD leader Martin Schulz said that his party's negotiators had agreed "unanimously" to recommend to the rank-and-file to back the draft coalition agreement and launch final negotiations on forming a government.
The 28-page deal was reached in a marathon negotiating session that lasted 24 hours at the end of almost a week of talks.
But he reconsidered his position after Merkel failed to form a three-way coalition with the Greens and the Free Democratic Party in November. "But I don't think we need a new instrument to do so", he said.
Nearly 16 weeks after her party won an inconclusive federal election, Merkel's second attempt to restore leadership in Europe's dominant country yielded progress, with an agreement to move on to a shared program for government.
Left party chairwoman Sahra Wagenknecht said the deal would perpetuate "blatant social injustice", including Germany's precarious low-wage sector and poverty in old age, while business raked in "gushing dividends".
Merkel has ruled with the SPD in a sometimes unwieldy "grand coalition" - or "GroKo", the German-language acronym - in two of her three previous terms in office, including in the last parliament from 2013-2017.
"We want to ensure economic and political power for Germany is put towards creating a stronger Europe", he added.
The three coalition parties' support dropped by a cumulative total of almost 14 percentage points in the election.
The SPD ran the risk of handing the opposition role in parliament to the new-entrant far-right Alternative for Germany (AfD), she said.
The parties agreed to limit numbers of refugees and migrants coming to Germany to around 200,000 following arrival of more than 1million asylum seekers since 2015.
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.
Despite the agreement, the possibility of a new coalition of Mrs Merkel's bloc with the Social Democrats, as governed Germany in the outgoing government, is still far from a done deal.
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.
Cap at 1,000 a month the number of people who will be allowed to join their family now living as refugees in Germany.
"We have, in what feels like a long time since the election, seen that the world will not wait for us", Merkel said. The SPD leader plans to tour local party chapters next week to sell the deal, while the SPD's youth organization plans protest rallies to lobby against it.
European Commission President Jean-Claude Juncker said he was "very satisfied" with the content of the deal.