Following a dismal result in Germany's Sept 24 election, the Social Democrats initially vowed not to enter another government with Merkel's conservatives, but they reconsidered their position after the long-time chancellor's attempts to form a coalition with two smaller parties collapsed.
"Many, many hours of work, serious wrangling and shaping are contained in these 28 pages", tweeted CDU politician Julia Kloeckner, part of Mrs Merkel's negotiating team, on Friday morning.
"We want to strengthen the European Union financially, so that it can better fulfill its tasks: which is why we will take this into account during the preparation of our financial framework for the upcoming years", the 28-page document, which the two parties agreed upon, said.
If things go well, a new government could be formed by April 1, said Horst Seehofer, the leader of the Christian Social Union - the Bavaria-only sister party to Merkel's Christian Democratic Union.
Commenting on the current political situation in the country, German President Frank-Walter Steinmeier said that "we are now facing a situation that has never happened before in the history of the Federal Republic of Germany, that is for nearly 70 years". It was enough for leaders of Merkel's two-party Union bloc and the Social Democrats to recommend moving on to formal coalition negotiations.
Italian Prime Minister Paolo Gentiloni commented via Twitter that the agreement between Merkel and Schulz was "a good item of news for Europe".
The euro jumped to a three-year high against the United States dollar after the deal was announced, reflecting the relief of analysts and the perceived importance of German leadership to the European economy.
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The European Commission president Jean-Claude Juncker endorsed the positive outcome of the talks: "In terms of the substance I'm very happy with what the CDU/CSU and the SPD have agreed", Juncker said during a news conference in Sofia.
The three coalition parties' support dropped by a cumulative total of almost 14 percentage points in the election.
"Government formation after the parliamentary vote in September is taking longer than we've ever seen in the federal republic", Frank-Walter Steinmeier, the German president, told foreign diplomats at a reception on Thursday night. The coalition paper foresees the new government drawing up a timetable for phasing out coal power by the end of this year.
"So I have no worries about us finding common solutions with France".
Under the deal, the number of refugees with "limited protection status" who could bring their families to join them would be limited to 1000 per month, and the number of asylum seekers taken in altogether would be limited to 180,000 to 220,000 per year. 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.
The SPD party base had to be mobilized, Bülow said, to "stop this grand coalition from within Social Democrats".