Schroeder announced his dramatic gamble after voters in the large regional state of North Rhine-Westphalia (NRW) kicked his Social Democrats (SPD) out of government after 39 years.
"We've had a political earthquake here," Johann Michael Moeller, a commentator for the daily Die Welt, said. "The SPD is on the ropes."
The call for a new election carries enormous risks for Schroeder, who has seen his personal ratings plunge as unemployment has surged to post-war highs.
In an instant survey conducted by ARD television on Sunday night, 46% of respondents said they would vote for the CDU and 29% for the SPD.
Voters appeared to be punishing him for the fact that his painful welfare cutbacks have produced little or no visible gain.
But he will hope to convince them that the plans of the conservatives, who have largely supported his reforms, will be even more painful.
"With the bitter election result for my party in North Rhine-Westphalia (NRW), political support for our reforms to continue has been called into question," a shaken-looking Schroeder told German television.
"With the bitter election result for my party ... political support for our reforms has been called into question"
Chancellor Gerhard Schroeder
"I see it as my responsibility and duty as German chancellor to persuade the president ... to call new elections for the Bundestag as quickly as possible, realistically by autumn 2005."
Two years ago, Schroeder unveiled a package of labour market reforms known as Agenda 2010 that sparked protests across the country. They include cuts in jobless benefits and stricter rules on means-testing for the long-term unemployed.
Federal elections are held every four years for Germany's lower house, the Bundestag, with the next one due at the end of 2006. Early elections are possible only in exceptional circumstances and the final decision rests with the president, currently the conservative Horst Koehler.
Schroeder could seek a vote of confidence in the Bundestag as early as next month. Should he lose that vote - which the government can try to lose deliberately - Koehler would have 21 days to decide whether to dissolve parliament.
There is a precedent for an early election. The Bundestag was dissolved early at the behest of Christian Democrat chancellor Helmut Kohl, who wanted new elections in March 1983 to expand his parliamentary majority.
Schroeder's shock announcement came after voters in NRW dealt the SPD its worst defeat since his re-election in 2002.
Preliminary results put the conservative Christian Democrats at 44.8%, against 37.1% for the SPD - enough to win control of a region Schroeder's party has ruled since 1966.
The CDU's likely coalition partners, the liberal Free Democrats, stood at 6.2%, giving the two parties an absolute majority.
Once an SPD stronghold, dominated by the coal and steel industry, NRW has fallen on hard times.
A million unemployed
Unemployment in the state, which borders on the Netherlands and Belgium and is home to a fifth of the population, recently pushed above the one million mark to a post-war high. Voters have blamed Schroeder's reforms for their woes.
New labour and welfare reform
plans have proven unpopular
The result strengthens the hand of Merkel, who stands a good chance of running against Schroeder in a bid to become Germany's first woman chancellor.
The prospect of early elections was expected to boost German stocks on Monday. Brokers said foreign investors would be drawn by the hope that a victory for the CDU could mean more far-reaching economic reforms.
Some analysts saw the move as a bid to silence left-wingers in the SPD, who have been clamouring for a change in direction, including a rollback of Schroeder's reforms and the introduction of more worker-friendly policies.
"It's sensational. I almost didn't believe it," Uwe Andersen, a political scientist at Ruhr University in Bochum, said.
"The only rational explanation I can think of is that someone from the SPD's left wing signalled to [SPD party chairman Franz] Muentefering that they would not support the government's current policy."
Regardless, Schroeder faces an uphill battle. The SPD has now seen its support decline in nine consecutive state elections. NRW was the last German state ruled by a coalition of the SPD and the leftist-environmentalist Greens, leaving the federal coalition in Berlin as the last Red-Green alliance.