Israel's Defence Minister Yoav Gallant signed a deal in Berlin with German Defence Minister Boris Pistorius after months of talks on the sale of the missile interceptor.
Mr Pistorius said it was a “historic day”. Mr Gallant, whose parents are Holocaust survivors, said the deal was a “moving event for every Jew”.
“Only 80 years since the end of the Second World War, yet Israel and Germany join hands today in building a safer future,” he said.
Mr Pistorius said the war in Ukraine, in which Russia has pounded civilian infrastructure with missile attacks, showed the importance of air defences.
The new missile system will make “German air defence ready for the future”, Mr Pistorius said.
Mr Gallant said the deal, estimated to be worth $3.5 billion, will also contribute to Israel's economy.
The Arrow system, developed by Israel Aerospace Industries and US plane-maker Boeing, is designed to detect, intercept and destroy incoming ballistic missiles. Manufacturers call it the world's best missile interceptor.
Germany is leading efforts to revamp Europe's air after Russia's invasion of Ukraine exposed the run-down state of its military. It has allocated €100 billion ($108.2 billion) to refurbish a military that has been in decline since the Cold War.
Some 19 countries have committed to the German-led Sky Shield project. France has not joined, preferring to develop European technology rather than rely on off-the-shelf American and Israeli equipment.
Israel is known for its highly advanced air defence capabilities, and the Arrow 3 has reportedly been used against incoming fire from Iran and Syria. The US had to approve the sale because of Boeing's involvement.
New Nato member Finland announced it would buy another Israeli system, David's Sling, in a €316 million ($332.6 million) deal this year.
While Israeli arms sales have been boosted by the war in Ukraine, Israel has refrained from sending arms to either side of the conflict.