A almost eight-hour meeting of the CSU in Munich was put on hold after the party's leader, interior minister Horst Seehofer, made his offer to resign both from Mrs Merkel's Cabinet and as head of the CSU.
The plan foresees turning away asylum seekers at Germany's border if they entered the European Union from another member state and first registered there.
The future of Merkel's governing coalition between the CDU-CSU alliance and the centre-left Social Democratic Party (SPD) appeared to hang by a thread, as media slammed what they called a reckless game of chicken.
A sharply weaker euro was an indication that the market was not very hopeful that an exit by Seehofer could be avoided‚ placing Merkel's three-month old - and carefully constructed - coalition in jeopardy.
As Merkel's party leadership met in Berlin, Seehofer encountered dissent in Munich in a meeting with the board of his CSU party, with divisions emerging over whether to pursue his plan to start turning away asylum seekers at the border in defiance of the chancellor.
"For the Christian Social Union (CSU) it is of utmost importance not to lose its credibility.The promise has been that Seehofer would stop immigration of those who are not entitled to go through the asylum procedure in Germany".
"The sum of all we've agreed is equivalent to what the CSU wants - that's my personal view, but the CSU must decide for themselves", she said.
Both the CDU and the CSU are holding separate meetings Sunday to discuss Merkel's latest efforts on migration and plot their next steps.
After a two-day summit with European Union leaders in Brussels last week, Mrs Merkel believed she had struck such a deal.
A Forsa poll showed that 67 percent of Germans thought the behavior of Seehofer and the CSU was irresponsible.
The CSU's Hans-Peter Friedrich, a former interior minister, told the Bild newspaper that "we can't make any more bad compromises".
"I'd like the CDU and CSU to continue working together because we're a success story for Germany", she said. She also would not speculate on whether she might fire him or if the issue could lead to a government confidence vote in parliament.
At the national level, Merkel proposes that migrants arriving in Germany who first registered in another European Union country should be placed in special "admission centres" under restrictive conditions, according to a document she sent to the CSU and SPD.
"Our goal remains a joint European solution with orderly protection of the exterior borders, and centres in third countries, ' said Kurz, whose nation took over the rotating EU presidency on Saturday".
Merkel, now barely 100 days into her fourth term, faced a backlash from the conservative CSU after allowing more than one million asylum-seekers into Germany since 2015.
CSU leaders, divided over how to face down a challenge from the anti-immigration Alternative for Germany (AfD) in October's regional election, were trying to persuade Seehofer to change his mind about resigning, the officials said.
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