In comments first reported by Focus magazine, Scholz is accused of referring to Christian Democratic Union politician Joe Chialo, who has Tanzanian family roots, as a "fig leaf" figure in his CDU party and a "court jester".
Scholz's main rival in the February 23rd election, CDU leader Friedrich Merz, wrote on X that the comments about Chialo, Berlin's top arts and culture official, had left him "speechless" and urged Scholz to apologise.
The CDU in a statement called the remarks racist and said they showed Scholz "lacks the character to hold office".
Scholz in a statement called the accusations of racism "absurd and artificially constructed".
"I personally value Joe Chialo as an important liberal voice in the CDU," he said.
Scholz said he had made the remarks during a conversation with a journalist about Merz's recent controversial ploy to push votes through the German parliament with the backing of the far-right AfD.
He was making the point that "only very few liberal voices in the CDU had spoken out against the behaviour of the CDU leader and criticised his words", Scholz said.
Scholz's Social Democratic Party (SPD) said he had called in a lawyer in response to the Focus magazine report and strongly denied that the comments were linked to Chialo's ethnicity.
"Focus is deliberately putting Olaf Scholz's statement in a racist context," the SPD said in a statement.
Merz in his X statement went on the offensive, writing that "what the chancellor said about Joe Chialo almost leaves me speechless".
"This is the chancellor who always demands respect, but obviously only for himself. What he has said now doesn't make things any better.
"I wonder whether he will ever be able to admit that he said something wrong and perhaps apologise for it."
The CDU's move last week to push a motion to restrict immigration through parliament with backing from the AfD broke a taboo among Germany's parties on working with the far right.
The action sparked mass protests against the CDU and Merz, as well as fierce criticism from Scholz and rights groups over the breach of the "firewall" against the AfD.
The CDU-CSU alliance is currently leading in the polls on around 29-30 percent, with Scholz's Social Democrats drifting around 16 percent.
The anti-immigration AfD meanwhile looks set for its best showing ever on around 20-21 percent.
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