Bournemouth striker Dominic Solanke has now scored nine goals in 16 games for England's U21s
European champions Germany scored a stoppage-time winner to bring an end to England U21s' 18-game unbeaten run.
England looked to have done enough to earn a draw at Bournemouth's Vitality Stadium but the unmarked Felix Uduokhai popped up with a late scrappy goal.
Dominic Solanke had earlier equalised after an excellent turn by Phil Foden, cancelling out Mahmoud Dahoud's opener.
Germany were good value for the win after dominating the first half and pressing for a winner after the break.
Borussia Dortmund midfielder Dahoud fired Germany in front with a smart finish after 27 minutes, and they came close to doubling their lead when Luca Waldschmidt hit the outside of the right post.
But Bournemouth striker Solanke, handed the captain's armband for the match at his home ground, looked sharp throughout and took advantage of Foden's deflected pass before rounding the goalkeeper and slotting into an open net to make it 1-1.
Germany pressed for a winner after the break, stretching the play and getting in behind England's defence on numerous occasions.
Hertha Berlin midfielder Arne Maier was their biggest threat. After setting up Dahoud with a lovely through ball for the opening goal, he also provided the pass for Waldschmidt's shot off the post and made a number of darting runs through the centre.
But it was Uduokhai who dealt the late blow amid some controversy.
England defender Kyle Walker-Peters appeared to suffer a head injury as he attempted to clear a Germany corner, but play was allowed to continue and when the ball broke to Uduokhai he fired into the net from close range.
England boss Aidy Boothroyd said: "If it's a terrific goal then you hold your hands up but it was a scrappy goal, in a friendly and the referee should have stopped play and awarded us a free-kick."
Foden impresses as Southgate watches on
Gareth Southgate handed starts to 18-year-old duo Jadon Sancho and Callum Hudson-Odoi in England's recent victories over Montenegro and the Czech Republic
England boss Gareth Southgate was at the Vitality to keep a close watch on the national team's next crop of young players.
Senior debuts this week for Callum Hudson-Odoi, 18, and Declan Rice, 20, again showed the clear pathway laid out for any young players who catch the eye.
One of those who will be knocking on the door is Manchester City's Foden. He has already made 23 appearances for Pep Guardiola's side this season - including 10 in the Premier League and four in the Champions League.
And he showed his class with a brilliant turn in the build-up to the equaliser - deceiving two defenders and using his quick feet to gain a yard of space before threading a deflected pass through to Solanke.
Another sharp turn and a mazy run from Foden earned England a free-kick just outside the box within minutes of the restart and he ruffled the side-netting with a powerful effort later in the second half.
Even with Germany dominating the midfield, Foden still looked a class above the rest and Southgate will have been impressed by his technical ability.
Man of the match - Phil Foden
Phil Foden's ability on the ball was excellent and he caused problems whenever he drove at Germany's defence
'The more he plays, the better he gets' - reaction
England U21s manager Aidy Boothroyd speaking to BT Sport: "We are disappointed because we want to win every game we play. It was a good test for us. It was two good teams having a go at each other.
"It's a horrible loss but we have to look at the positives. I thought Phil Foden was exceptional and it was nice to see Dominic Solanke get on the scoresheet again. Foden has a lovely weight of pass and he has so much talent. The more he plays with us, the better he will get. No doubt about it.
"I am really pleased for Solanke because his work off the ball was terrific. He made some good runs and got what he deserved."
