Merkel condemned the organisers of the protests and said they were driven by prejudices and hatred against foreigners.
The chancellor used unusually direct words in her New Year's speech for the rallies organised by a group calling itself Patriotic Europeans against the Islamization of the West, or PEGIDA which have been attended by thousands.
When the protesters chant "we are the people," they actually mean to say "you don't belong because of your religion or your skin color," Merkel said.
Immigration has emerged as a contentious topic lately in Germany, partly due to a sharp rise in asylum applications, particularly from Syrians.
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However, Merkel also referred to this topic and stressed that refugees from wars and crises around the globe are welcome in Germany, saying many of them "literally escaped death."
"It goes without saying that we will help them and accommodate people who are looking for refuge," the chancellor said.