Opinion polls show Merkel's Christian Democrats (CDU) will win about 22 percent of the vote in the city-state of Berlin on Sunday and come a distant second to the centre-left Social Democrats (SPD), who are forecast to win about 31 percent and stay in power with either the Greens or the Left Party.
Polls in Berlin opened at 8 am (0600 GMT) and the first exit polls will be announced immediately after polls close at 6 pm (1400 GMT). It was raining heavily in Berlin on Sunday morning and weather forecasts called for more showers.
There could be more bad news for Merkel's centre-right coalition in Berlin if her junior coalition partners, the Free Democrats (FDP), fail to win at least five percent of the vote and are ejected from the state assembly.
It would be the fifth time in seven elections this year that the FDP had failed to win five percent and could increase pressure on the party, which won a record 14.6 percent in the 2009 federal election, to remove Foreign Minister Guido Westerwelle. Polls show the FDP at about 2 percent.
Another surprise on Sunday could be the performance of the Pirate Party, a German branch of a party that emerged in Sweden five years ago to campaign for reform of copyright and better privacy in the Internet age. Polls show the party winning 9 percent.
Merkel, under fire for her hesitant leadership in the eurozone crisis, is halfway through a four-year term. But election setbacks for her CDU have hurt her standing before the vote on eurozone measures in parliament at the end of September.
SPD BUILDS MOMENTUM
The SPD, in opposition at the national level since 2009, wants likely re-election in Berlin on Sunday to build up momentum to oust Merkel in the next federal election in 2013.
The SPD has ousted or helped defeat the CDU in Hamburg and Baden-Wuerttemberg this year and remained in power elsewhere.
The CDU has lost five of six regional votes. A bad result in Berlin, Germany's largest city with 3.4 million, would add to Merkel's woes before the vote in the Bundestag on 29 September to give the European Financial Stability Fund (EFSF) more powers.
The euro crisis has crept into the campaign in Berlin, with Merkel using a local radio interview ostensibly on city issues to quash talk of an imminent Greek default.
Klaus Wowereit of the SPD, Berlin's mayor, should be re-elected for a third term after finishing strongly in what appeared to be a tight battle against the environmentalist Green Party.
Victory could bolster Wowereit's credentials as the darling of the SPD's left and make him a candidate to run against Merkel in 2013. So far former finance minister Peer Steinbrueck, on the SPD's right, has seemed to be the front runner.
The CDU candidate against Wowereit attracted little enthusiasm and the party will be fortunate to do better than in the last election in 2006 - 21.3 percent. The Greens are projected to win 18 percent while the Left - Wowereit's current partners in city government -- are expected to win 11 percent.
A spate of apparently random night-time arson attacks on cars in Berlin, with more than 530 set alight, gave the CDU a chance to attack Wowereit's record on crime-fighting.
But the mayor's distinctive Berlin accent, charismatic smile and popular touch have lifted his party in opinion polls. One of his campaign posters shows a toddler with an impish smile trying to bite off Wowereit's nose with her glove puppet.
Wowereit has ruled in alliance with the Left for 10 years but could switch allegiance to the Greens.
The Greens, whose popularity soared earlier this year after Japan's nuclear disaster, had hoped to win in Berlin after taking the prosperous Baden-Wuerttemberg state from the CDU. With former cabinet minister Renate Kuenast as the party's mayoral candidate; it was ahead in some polls in late 2010 and early 2011, until Wowereit managed to rally.