The Arrow 3 system -- an interceptor designed to shoot down ballistic missiles above the Earth's atmosphere -- is jointly developed and produced by the Israel and the United States.
Israel's defence ministry said in a statement the US State Department had notified it of the US government's approval for Germany to procure the Arrow 3 system.
"The Israeli Ministry of Defence, German Federal Ministry of Defence, and Israel Aerospace Industries will sign the landmark $3.5 billion defence agreement, marking Israel's largest ever defence deal," it said.
The ministry said senior officials from the Israeli and German defence ministries would sign a letter of commitment to the deal with a preliminary payment of $600 million.
"With its exceptional long-range interception capabilities, operating at high altitudes above the atmosphere, (the Arrow 3) stands as the top interceptor of its kind," it said.
"The system employs a hit-to-kill approach for intercepting incoming threats."
Israeli Defence Minister Yoav Gallant, quoted in the statement, called the agreement "the largest in Israel's history".
"This is a significant decision, which will contribute to Israel's force buildup and economy," he said.
"It is also particularly meaningful to every Jewish person, that Germany is acquiring Israeli defence capabilities."
Partly financed by the United States, the Arrow system was developed and produced by Israeli Aerospace Industries (IAI) in partnership with Boeing.
The Arrow 3 can intercept ballistic missiles fired from a distance of up to 2,400 kilometres (1,490 miles), according to IAI.
The system was first deployed in an Israeli air force base in 2017 and has been used to protect Israel against attacks from Iran and Syria.
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The final contract for the deal is expected to be signed by end of 2023 after it is approved by the parliaments of both Germany and Israel, the Israeli defence ministry said.
Berlin expects the Arrow 3 system to be delivered in the final quarter of 2025.
The German government has led a push to bolster NATO's air defences in Europe after seeing Russia's relentless missile strikes on Ukraine, urging allies to buy deterrence systems together.
More than a dozen European countries have so far signed up to the so-called European Sky Shield initiative.
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