After scandals over US surveillance programmes that spooked Europeans, Deutsche Telekom will serve as "custodian" for Microsoft's cloud-based services in Germany.
"All customer data will remain exclusively in Germany," Deutsche Telekom said in a statement, adding that the service will also be available to European clients outside Germany.
"With this partnership with T-Systems, Microsoft customers can choose a data protection level that complies with the requirements of German customers and many clients of the public sector," added Anette Bronder, director of Digital Division at the Deutsche Telekom subsidiary T-Systems.
Microsoft runs its German cloud-based services through two data centres, where Deutsche Telekom will assume responsibility for "protection of customer data and access to it".
"Microsoft will have no access to the data if T-Systems or the customer do not allow it," the statement said, a point confirmed in a separate communique from the US group.
Trust in US tech companies has been shaken since former US National Security Agency (NSA) analyst Edward Snowden in 2013 revealed a worldwide surveillance programme using user data harvested from Silicon Valley giants.
The outrage was particularly deeply felt in Germany, where memories of abuses under the Nazi and communist East German regimes loom large and where it emerged that the NSA even snooped on Chancellor Angela Merkel's mobile phone.
However recent media reports have also pointed to sweeping secret cooperation between the NSA and Germany's BND foreign intelligence service, and BND spying on German allies.
Last month the EU's top court issued a landmark verdict striking down a key transatlantic data deal, saying that internet giants could be barred from sending European citizens' personal information to the US in the wake of the Snowden scandal.
The landmark verdict stemmed from a case lodged by Austrian law student Max Schrems, who challenged the 2000 "Safe Harbour" agreement between Washington and Brussels on the grounds it did not properly protect European data.