Her Christian Democratic Union (CDU) clinched 33 percent of the vote in North Rhine-Westphalia (NRW), preliminary results showed, snatching control of the sprawling industrial region which has been a Social Democratic Party (SPD) stronghold for decades.
The SPD only managed to garner a little over 31 percent, its worst score in history in the state and sharply down from its 2012 showing of 39.1 percent, in a serious hit to confidence ahead of general elections in September.
SPD leader Martin Schulz admitted that the loss in his home state marked a "difficult day for the SPD" and for him personally, but urged supporters to battle on.
"We received a body blow, but we are still striving in the ring... now we're going into the next round, the deciding round. At the end, when we look to the judge, it's going to be the voters who raise the winner's arms," he said.
The former European Parliament president turned to France for courage.
"My friend Emmanuel Macron was at the bottom five months ago, and now, he is president," said Schulz of the new French leader who took office on Sunday.
But Germany's best-selling daily Bild noted that "with the clear state election failures, it would be very difficult for the SPD to win the general elections in September."
Likewise, Spiegel Online said: "Martin Schulz now needs a miracle."
With a fifth of Germans - 13.1 million - eligible to vote in North Rhine-Westphalia, an election in the western state is always closely watched.
It carries even higher stakes this year, being the last regional vote before national polls and having a direct impact on whether the SPD can close a nationwide gap of around 10 percentage points with the CDU.
"We are going into the national elections with a lot of confidence," said lawmaker Michael Grosse-Broemer, who heads the CDU parliamentary group in the Bundestag, noting that the latest win gave the party further "tailwind".
The SPD had already suffered two setbacks since Schulz took over, with the CDU scoring strong victories in the small states of Saarland and Schleswig-Holstein.
Sunday's humiliating result in its stronghold may raise serious questions on the centre-left party's strategy.
Schulz had hoped that his push for "social justice" would resonate in NRW, which has lagged behind western Germany economically.
He argued that many people are struggling in temporary or low-paid jobs even though the country as a whole is growing richer.
But Merkel, who had also gone all out to sway the state of 18 million people, including 4.2 million of migrant origin, took aim at Schulz's arguments.
Her party, she said, offered "justice in the sense of jobs, strong budgets, funds for local communities."
She had urged voters to look at her government's economic record, noting that with 7.5 percent unemployment, the state fares worse than the national rate of 5.8 percent.
The state's SPD-led governing coalition has also been under fire over security failures, and junior partner Greens also suffered a setback Sunday with polling reaching 6.4 percent, just above half of the 2012 score of 11.3 percent.
State interior minister Ralf Jaeger has faced criticism for failing to detain Anis Amri, the Tunisian asylum seeker suspected in the deadly Berlin Christmas market rampage last year.
Amri had lived in the state and was deemed a threat by intelligence officials, but Jaeger argued that there was insufficient evidence to lock him up.
On Jaeger's watch, Cologne also became the scene of mass sexual assaults by groups of mostly North African men on New Year's Eve of 2015-2016, inflaming the debate over the 890,000 asylum seekers Germany welcomed in 2015.
The populist AfD (Alternative for Germany), which has railed against the migration influx, on Sunday secured its first seats in NRW, which would see it represented in 13 of 16 state parliaments.
Liberal party FDP saw a revival, polling at 12.6 percent in the state, after being consigned to political wilderness when it failed to cross the five-percent hurdle in national election in 2013.
By Richard Heister with Hui Min Neo