In a rematch of the 2009 final, Federer opened like a train but he was gradually reeled in by the tenacious Nadal to suffer his fifth straight grand slam defeat to his great rival, 6-7 (5/7), 6-2, 7-6 (7/5), 6-4.
“For me it’s a dream to be back in the final,” said a smiling Nadal.
“It’s a real honour to play against Roger, it was a fantastic match. It’s fantastic to have one player in front of you who doesn’t make mistakes, having a totally complete game.”
Nadal will now face either defending champion Novak Djokovic or fourth seed Andy Murray, who play on Friday, as he looks for his second Australian Open crown and his 11th grand slam title.
The 25-year-old strengthened his spell-binding hold on the otherwise masterful Swiss, who has won only two of their 10 grand slam meetings, both at Wimbledon, and none since 2007.
Three years ago, Federer wept openly when Nadal won their epic, five-set Melbourne final. And on a chilly Melbourne night there was no revenge for the 16-time slam winner, who now extends a two-year major drought.
Federer produced flawless tennis at the start of the match but his game unravelled when put under pressure by Nadal and he finished with 63 unforced errors.
The Swiss broke immediately with a flashing backhand winner but he was broken back before edging the first-set tiebreak.
Nadal won the key break in the second set and levelled the match after a 10-minute break for Australia Day fireworks shot Federer’s concentration to bits.
The Spaniard needed six set points to take a two-sets-to-one lead in the third-set tiebreak and he broke in game nine of the fourth before finally serving out the win.
Earlier, former champion Maria Sharapova and Belarus’s Victoria Azarenka set up a fight for both the Australian Open title and the number one ranking after winning nerve-wracking semi-finals.
Russia’s Sharapova gained sweet revenge for her Wimbledon final defeat to Petra Kvitova, after Azarenka survived a second-set collapse against defending champion Kim Clijsters to reach her first major title match.
“I felt like my hand is about 200 kilograms and my body is about 1,000 kilograms,” Azarenka said, wiping away tears. “Everything is shaking.”
Both semi-finals went to three tense sets with Sharapova winning 6-2, 3-6, 6-4 and Azarenka beating Clijsters 6-4, 1-6, 6-3.
The Australian Open has heralded a shake-up in women’s tennis with Denmark’s Caroline Wozniacki set to drop from world number one to four, and with Clijsters now following long-dominant Serena Williams out of the tournament.
Azarenka can now claim Belarus’s first ever grand slam title in Saturday’s final, while resurgent Sharapova gets another shot at breaking a four-year major drought since her previous Melbourne win in 2008.
Third seed Azarenka, 22, wept on court after she upset four-time slam champion Clijsters to go one step better than her previous grand slam best of reaching the semi-finals at last year’s Wimbledon.
She has often faltered on the big stage, most noticeably at the 2010 Australian Open when she led eventual champion Williams before imploding. But she stood firm Thursday to hold off Clijsters’ strong revival.
“Before, I think you all thought I was a mental case but I was just young and emotional,” she said. “But I’m really glad the way I fought. That’s the thing I’m most proud of, I fought for every ball.”
In the second semi-final, a re-run of last year’s Wimbledon decider, Kvitova and Sharapova threw everything at each other for almost two-and-a-quarter hours on Rod Laver Arena.
Sharapova dominated the first set and Kvitova the second, with the pair evenly matched in the third until Kvitova faltered at 4-5 to lose her serve and send Sharapova through to the final.