"I think it's looking quite good and the car feels good, especially in the last section. Ferrari looked extremely competitive. McLaren had a difficult day with only one car for the majority of running, but they will come back and be up there," Vettel said.
He was followed by Brazilian Felipe Massa, a further 0.2 seconds adrift in the second Ferrari.
Ferrari eyes recovery
Ferrari needs to recover ground with two straight sub-par results having left Alonso in fifth place with 98 points and Massa in eighth with 67.
"In order to be in front tomorrow, we will have to do something out of the ordinary," Alonso said.
Australian Mark Webber was fourth quickest in the second Red Bull ahead of Mercedes drivers Nico Rosberg and Michael Schumacher who were fifth and sixth quickest respectively.
McLaren driver Lewis Hamilton sat out most of the session out while his team repaired his car after a crash, but rejoined the session late on.
"I damaged the car quite heavily this morning. It was very slippery and I hit the limiter coming out of Turn Three, shifted gear, which spun the wheels, and had an oversteer moment," said the Briton.
"I tried to correct it and that put me onto the grass, where I was just a passenger."
The Briton, a winner at Hockenheim as he won the driver's championship in 2008, still managed to set the seventh fastest time despite completing just 10 laps after lunch.
"The accident took all four corners off the car, so I was a little bit upset with myself," Hamilton said.
"The guys work so hard during the week to get the car ready, and then you get to the track, do a few laps, and total the car, which isn't great. It was a huge amount of work for the guys, too, but they've just been phenomenal."
Hamilton's team-mate and defending drivers' champion Jenson Button was well off the pace, clocking the 15th fastest time.
Sunday's German GP is the 11th of the season's 19 races.