Scholz is widely expected to become finance minister and vice chancellor in the new government if the coalition agreement is approved.
Mrs Merkel faces growing internal dissent over her decision to give the post of finance minister to Olaf Scholz, a Social Democrat (SPD), during hard coalition talks last week.
Prime Minister Binali Yıldırım wil meet with German Chancellor Angela Merkel Thursday at the Chancellery in Berlin as part of his visit to the European country to attend a security conference in Munich. If members reject the coalition pact, a new German election looks the most likely option.
Seeking to end the infighting, chairman Martin Schulz said Tuesday that he was resigning effective immediately.
Relations between the two countries have been strained since the defeated 2016 coup in Turkey as Turkish politicians criticized their German counterparts for failing to show strong solidarity with Ankara against the attempted military takeover on July 15, 2016 and the decision in Germany to ban rallies by Turkish ministers and President Recep Tayyip Erdoğan a year ago. The party's youth wing is already campaigning for a no-vote as it fears that another grand coalition with Mrs Merkel's conservatives will further erode the party's identity.
Appearing on the public broadcaster ZDF on Sunday night, Merkel had spoken out in favor of handing key CDU posts to younger politicians.
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"The SPD needs an organizational, programmatic and personnel renewal, and I wanted to facilitate that", Schulz told reporters in Berlin in announcing his retreat.
The SPD will now put a coalition deal to its 460,000 members for a vote later this month, with results due on March 4.
Two sources in the SPD leadership said the party decided not to make Ms Nahles a caretaker leader because it did not want to pre-empt a vote at the party congress and so possibly influence the members' vote on a coalition.
The development followed Schulz's announcement Friday that he was abandoning plans to become foreign minister in the new government.
The turmoil in the SPD can only distract from criticism of Ms Merkel from within her own party after she handed the foreign and finance ministries to the SPD to secure the coalition deal.
That leaves open who from within the SPD may take up that post.