Germany will allow babies born with no clear gender-determining anatomy to be put on the national birth register without a "male" or "female" classification.
The "third gender option" takes effect November 1.
A study by the German Ethics Council concluded that the rights of intersex individuals against irreversible medical interventions should be better protected.
"If a child cannot be designated male or female, then they should be entered on the birth register without such a status," the country's new law states.
At least 150 intersex babies are born in Germany each year up to 10,000 people have "serious variations" from physical gender-defining characteristics.
A spokesman for the German Interior Ministry said:
"A key aim of the new rule is to relieve parents of the pressure of having to decide a sex straight after the birth, and thereby agreeing overly hastily to medical procedures."
Support groups say the number of intersex individuals is far higher than estimated, and point out the difficulties and subtleties of defining intersexuality physically or hormonally.
The interior ministry spokesman said the change did not amount to the "creation of a third gender" because the box stipulating male or female is left blank.
Creating a third gender would complicate German laws on marriages and partnerships, which operate on a binary male-female opposition, analysts say.
"This is an interesting move but it doesn't go far enough," said Silvan Agius of Equality for lesbian, gay, bisexual, trans and intersex people in Europe (ILGA).
"Unnecessary surgeries will continue in Germany with devastating consequences... we live in a world where having a baby classified as 'other' is still considered undesirable."
Other campaigners for rights of intersex people raised concern that the "outing" of babies as intersex on official records could lead to discrimination in schools.
The law, a first for Europe, is not unprecedented on a global scale. Australia has allowed citizens to note their gender on a passport as "X" since 2011.