Regarding the decision she had to make, Merkel had two choices. If she declined to prosecute then she would be making a quasi-judicial decision in a county where judicial decisions are rightly made by the courts, not politicians. In passing the decision to the courts she is, in my opinion, making a clear statement of German values:
this is how we do things - with the rule of law.
Which starkly contrasts with Erdoğan's contempt for the rule of law and anything that gets in his way.
The German constitution guarantees freedom of expression and the case will undoubtedly be dismissed when it reaches the courts.
(And I agree that laws such as this should be abolished.)