Merkel announced that she will step aside as leader of the Christian Democratic Union (CDU) at the party's conference in December and will not run for re-election in 2021.
"Today it is time to begin a new chapter", she told reporters at her party headquarters.
However she has come under mounting pressure in recent months, culminating in a disastrous result for Germany's ruling parties in state elections this weekend. Merkel has said that she will not endorse any of the candidates running to replace her. Merkel has held this position for two decades.
Merkel has loomed large on the European stage since 2005, helping guide the EU through the euro zone crisis and opening Germany's doors to migrants fleeing war in the Middle East in 2015 - a move that still divides the bloc and Germany.
Projections for ARD and ZDF public television, based on exit polls and partial counting, gave the CDU 27-28% support and the centre-left Social Democrats about 20%. Her fourth-term government took office only in March but has become notorious for squabbling.
She intends to remain as chancellor until 2021, until the parliamentary term runs out, the Associated Press cited her saying.
German Chancellor Angela Merkel is stepping down from her party's chairwoman position. He governs Schleswig-Holstein in a three-way coalition with the pro-business Free Democratic Party and the environmental Greens-a model that Merkel tried and failed to set up at the federal level a year ago after the FDP withdrew.
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Merkel's preferred heir, Annegret Kramp-Karrenbauer, wants to continue in her tradition of moderation and big-tent centrism. This rout comes just two weeks after Bavaria's state election, which was also a disappointing result for the conservative Christian Social Union, the CDU's Bavarian sister party.
The arrival of more than a million asylum seekers since has not only left a deep chasm in German society, it has also empowered a far-right party that has upended German politics.
She argued that the three governing parties should instead, after the Hesse vote, prioritize a few policies and implement them as "an important signal" to Germans of the government's effectiveness.
Merkel has dragged the CDU to the political center in her years as leader, dropping military conscription, introducing benefits encouraging fathers to look after their young children, and abruptly accelerating the shutdown of Germany's nuclear power plants following Japan's Fukushima disaster in 2011.
According to projections updated around 8pm, Ms. Merkel's CDU remained the strongest party in Hesse.
Increasing numbers of SPD members have been calling for the party to quit government and lick its wounds in opposition, as it is presently polling below AfD nationwide, at 15 percent to the far-right's 16 percent.