The decision came following Christian Wulff's resignation from the post Friday over a corruption probe and after members of Merkel's own conservative party dropped their objections to Gauck, 72.
Merkel, who like Gauck grew up in communist East Germany and is a Protestant, hailed the popular pastor as a "true teacher of democracy" who had helped the country come together since its reunification in 1990.
"This man can provide an important impetus for the challenges of our time and the future," she said after meeting with representatives of her centre-right government and the opposition at the chancellery in central Berlin late Sunday.
Gauck was the candidate of the opposition Social Democrats and Greens in June 2010 against Wulff, a former Christian Democrat state premier and Merkel's hand-picked choice for the largely ceremonial office as a kind of moral arbiter for the nation.
Despite Merkel's strong backing, Wulff was only elected in the third round of voting - a messy start to a doomed presidency.
The mainstream opposition put forward Gauck this time as well following Wulff's decision to step down. Only the far-left Die Linke, which includes several former East German communists, said it would withhold support when the president is elected in March.
Conservatives were initially reluctant to support him as they saw it as losing face and a political gift to the opposition but their desire to end a damaging chapter won out in the end.
Gauck's victory is now assured with a clear majority of support in the assembly comprised of deputies and dignitaries that chooses the president, meaning two former East Germans will occupy the most important political offices in the country.
A visibly moved Gauck, who a majority of Germans say can restore credibility to the damaged office after Wulff's series of scandals, said he was deeply honoured to be nominated.
"It is a very special day for me, even in a life where I have had several," he told reporters.
He said he was pleased that "someone like me, born during a terrible war and who lived 50 years under a dictatorship... should be called upon today become head of state" and now wanted to help restore Germans' "faith in their own strength" in the face of the eurozone crisis.
But Gauck, who belongs to no party, confessed he was "overwhelmed and a little confused" at having become a political football twice in two years.
"All's well that ends well," the Social Democrats' leader Sigmar Gabriel quipped.
Born in January 1940 in the northeastern city of Rostock, Gauck became a Lutheran pastor under the communist state and used the relative freedom granted to churches to defend human rights.
Gauck was a leader of the peaceful revolution that helped topple the Berlin Wall in 1989 and the next year became head of the vast archives left behind by East Germany's dreaded Stasi secret police.
He served there until 2000, earning respect for balancing the causes of truth and reconciliation as the country again became one.
Imposing in stature with a ready smile, Gauck was called "the president of hearts" during his first run for the office in 2010 by the top-selling Bild daily, which had a large part in bringing down Wulff.
The former president, already the second on Merkel's watch, had endured a barrage of negative media coverage since December largely over his links with wealthy businessmen while leader of Lower Saxony state.
He stepped down Friday after prosecutors sought the lifting of his legal immunity to probe allegations he had enjoyed favours from a film producer friend who later received a state loan guarantee he was seeking.
Merkel, who cancelled a trip to Rome Friday for eurozone crisis talks with Italian Prime Minister Mario Monti, had pledged to find a cross-party replacement.
Germany's 11th postwar president must be elected within 30 days of Wulff's resignation.