"Lufthansa informed Air Berlin and its insolvency managers that it will pursue the planned transaction without the purchase of Niki," the airline said in a statement.
Germany's second-largest carrier triggered bankruptcy proceedings in August after losing a cash lifeline from its biggest shareholder Etihad Airways.
Its aircraft were kept aloft by a 150-million-euro emergency loan from the German government while it negotiated the sale of its assets.
Meanwhile, Niki's aircraft have continued to fly as it is not subject to the same bankruptcy conditions as Air Berlin.
Wednesday's decision could pitch the airline into financial turbulence as it loses bridge financing from the German giant.
"We regret the Commission's decision on Niki very much," the German government said in a statement.
"There are no alternative buyers for Niki available at the moment despite all the efforts of the insolvency managers... insolvency and grounding will be the consequence," it added.
According to Vienna airport's website, four of five Niki flights scheduled for Thursday have been cancelled.
Air Berlin said in a statement Tuesday that prospective buyers IAG had withdrawn their interest in Niki, while there was also no workable offer from Thomas Cook, leaving Lufthansa as the group's only option for sale.
The European Commission said last week it had "deep competition concerns" about Lufthana's hoped-for buyout of 81 aircraft from Air Berlin's 140-strong fleet plus Niki for 210 million euros ($250 million).
Lufthansa had already offered to give up many of the precious takeoff and landing slots it originally wanted under the deal.
But "the Commission saw this step as unsatisfactory and signalled clearly that it could not allow taking over and integrating Niki into the Eurowings group," Lufthansa's low-cost subsidiary, the firm said.
The German group also offered Wednesday to give up further slots belonging to Air Berlin subsidiary LGW.