"This was a very important message for Middle East peace process ... I very much support the fact that the US president has said that security and borders have to be talked about first of all," Merkel told reporters in Berlin.
"The proposal to use the 1967 border and to consider conducting land swaps ... would be a good path that both sides should consider," she said.
Obama said Thursday that the borders of Israel and a Palestinian state must be based on borders in place before the 1967 Arab-Israeli war through mutually agreed swaps.
"I also support what the president said about unilateral measures, no matter from which side," Merkel said. "Neither settlement-building nor a unilateral recognition of a Palestinian state would help advance the (peace) process."
Obama warned Palestinians however that Israel had a right to defend itself and said that the unity deal between Fatah and the radical Islamist Hamas movement posed "profound and legitimate questions" for Israel.
He also bluntly told Palestinians that their effort, following the collapse of US-brokered direct talks with Israel last year, to try to win recognition at the UN General Assembly in September would fail.
Germany, traditionally one of Israel's closest allies and which currently holds a non-permanent seat in the UN Security Council, has also spoken out against a "unilateral" declaration of Palestinian statehood.
In the long-awaited response to the "Arab spring" of revolts, Obama also compared "shouts of human dignity" across the Arab world to America's birth pangs and civil rights struggles.
German Foreign Minister Guido Westerwelle called these comments a "powerful signal of support for democratic change in North Africa and the Arab world as a whole.
"It will give a boost to all those working for more freedom, democracy and opportunities for personal prosperity in the region."