Merkel has taken a strong public stance in recent weeks against groups such as Patriotic Europeans against the Islamization of the West, or PEGIDA. The group mobilized 25,000 supporters Monday for an anti-Islam protest in the eastern city of Dresden.
About 7,000 more protesters than last week turned out for the march, a police spokesman said.
"Excluding population groups due to their faith or their origin is beneath the dignity of our liberal state," she said in a speech in Berlin. "Hatred of foreigners, racism and extremism have no place in this country."
Merkel will be joined by German President Joachim Gauck at a rally organized by Muslim groups near Berlin's iconic Brandenburg Gate.
PEGIDA's anti-Islam protests began twelve weeks ago and have grown steadily, tapping into fears among some Germans that the country is being flooded by Muslim immigrants.
In remarks that angered the group, Merkel quoted a former German president ahead of the Monday rally. "Former president Wulff said Islam belongs to Germany. That is true. I also hold this opinion," Merkel said at a news conference.
Germany has some 4 million Muslim residents, mostly of Turkish origin. That is equivalent to about 5 percent of the population of 80 million.
Reuters and the Associated Press contributed to this report.