Diego, who helped Atletico win the Europa League during his previous spell in Spain during the 2011/12 season, is to return to the Rojiblancos until the end of the season, subject to a successful medical.
The 28-year-old playmaker recently said he was committed to staying with Wolfsburg until his contract with the Bundesliga club ran out in the summer, but he was unable to turn down the chance to go back to Madrid.
He said on www.clubatleticodemadrid.com: "I feel very excited. I'm returning to team where I felt fantastically well. I'm only thinking about getting to work to help the team continue winning."
Atletico are currently joint top of the Primera Division, through to the semi-finals of the Copa del Rey and in the last 16 of the Champions League, and Diego insisted he knew the team were heading for big things when he was last at the club.
"It was a matter of time before Atletico reached where they are. I already saw the potential of the team and the club when I was here," he said.
Wolfsburg director of sport Klaus Allofs admitted they would like to have kept hold of Diego.
He said: "Diego came to us with the request to be able to move to Atletico. We ultimately agreed to it, even if we would have liked to have carried on working with Diego at least until the summer.
"His immediate transfer is regrettable because Diego has always been highly-professional, but hopefully it only means a short-term drop in quality for our team.
"We still have a good enough squad to be able to carry on following our objectives and we wish Diego much joy and success with Atletico."
Diego thanked Wolfsburg for agreeing to let him leave five months before his contract was due to expire.
"I'd like to thank Wolfsburg, particularly Klaus Allofs and (coach) Dieter Hecking who have agreed to my request to leave and were always very open with me," he said.
"I had a super time in Wolfsburg overall. Our fans always gave me excellent support and I'd like to say many thanks once again to them.
"I wish Wolfsburg all the best."