The first set was played yesterday and it was Kerber who led 7-5 entering today's action after Watson failed to take advantage of two set points.
Watson got off to the ideal start upon the resumption, winning the first eight points to open up an early 2-0 lead, but it was soon 3-2 to Kerber as the German got her act together.
However, Watson then took over by winning four games in a row to level the match at one set apiece and force a decider.
Kerber took the initiative to race into to a 5-1 lead, but Watson then won three games in a row, including two breaks of serve, to restore parity.
She had to consolidate the last break-back, but was not able to do so as Kerber squeezed through to the last 32, where she will meet 24th seed Svetlana Kuznetsova.