However, the battling Brit did not go down lightly as Kerber sneaked across the finishing line in three sets, winning 7-5 3-6 6-4 after two hours and 32 minutes on court.
The match had begun on Friday when bad weather brought an early end to proceedings after Kerber had wrapped up a close first set.
Watson had led 5-3 in the opener and also held a brace of set points in games nine and 10, but was unable to prevent her German opponent from reeling off four games in a row.
On their return on Saturday morning, world No 41 Watson levelled matters by winning four in a row herself from 2-3 down, before slipping 1-5 behind in the decider.
But from there, she broke serve twice to reduce the arrears to 4-5 only for the 22-year-old from Guernsey to lose her own service to 15 in game 10, as the No 13 seed sealed a hard-fought victory.
The 27-year-old from Bremen now faces two-time Grand Slam winner, and No 24 seed, Svetlana Kuznetsova with the winner claiming a berth in the last 16.
Elsewhere, there was a surprise win for another German as Tatjana Maria beat last year???s Wimbledon finalist Eugenie Bouchard in straight sets.
The No 6 seed from Canada lost 6-0 7-6 (7-4) in a contest of contrasting sets.
After losing the first in 34 minutes, she made more of a fight of it in the next against the world No 113 who has never won a title on the WTA Tour.
Bouchard had served for the second set in the 10th game, and also threw away a 3-1 lead in the tie-break, before losing six of the last seven points.??