"Martin Schulz will be the candidate for the chancellorship", Gabriel told reporters in Berlin, adding that the choice was "unanimously" endorsed by the party leadership.
The shocking news reported Tuesday by multiple German newspapers may lead to a less predictable election.
While Gabriel did not elaborate on his reasons for stepping down ahead of the general election, he told Stern tabloid in an interview on Wednesday that he did not believe the SPD could win with him as the face of the party.
Former European Parliament president Martin Schulz is set to be the leading candidate of the German Social-Democratic Party (SPD) for the elections later this year, after the party's leader Sigmar Gabriel stepped down on Tuesday.
Gabriel also said that the SPD Presidium would make a decision on Sunday regarding the candidacy for the post of the German foreign minister.
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The nomination followed SPD leader Sigmar Gabriel's decision to stand aside for Schulz, a move that shows the SPD is serious about ending its role as a junior partner in Merkel's current right-left coalition.
Still, if the shakeup improves the party's fortunes, that would open a new front against Merkel, who is already confronting a challenge from the anti-immigration Alternative for Germany party over her open-border refugee policy.
Ms Merkel will be running for a fourth term, although it is not clear who would join her in a coalition government. Gabriel is the longest serving leader of the SPD since former Chancellor Willy Brandt.
Gabriel said the party has also agreed that he should replace Frank-Walter Steinmeier as foreign minister.
Ms Merkel's conservative bloc is now leading in the polls on about 36 per cent, followed by the SDP with around 21 per cent and the AFD on 12 per cent.