The mid-afternoon clash was not one of the best in their 32-match series as Federer faded badly in the second set to hand Nadal his first victory over him on an indoor court.
Nadal was thrashed 6-3 6-0 by Federer at the o2 Arena two years ago but after a tight first proved too strong for the 32-year-old Swiss who looked weary after his three-set victory over Juan Martin Del Potro on Saturday.
The year could now have a mouth-watering grand finale with Nadal up against defending champion and world number two Novak Djokovic on Monday although Swiss Stansilas Wawrinka will be hoping to ruin the script in the second semi-final later.
Federer had the first chance on Sunday when he put the world number one in trouble on serve in the sixth game but Nadal held firm and broke Federer's serve to lead 5-4.
The Swiss played a scintillating point at 15-30 in the next game, ending an exhausting baseline exchange when he rifled a forehand down the line and Nadal ballooned out a forehand to hand Federer the break back.
However, a third consecutive break of serve gave Nadal a second chance to take the opener and this time he made no mistake with a clinical love game.
When a Federer forehand nose-dived into the net on break point at 2-2 the belief seemed to drain out of the 32-year-old and the end came quickly as Nadal extended his career record over the 17-times grand slam champion to 22-10.
"It's the perfect way to finish one of the best seasons of my career to have the chance to win a title I've never won," Nadal, who has won everything in the sport apart from the season-ending tournament, said on court.
Australian Open champion Djokovic is unbeaten since losing the U.S. Open final to Nadal in September while Nadal, whose 10 titles this year include the French Open, hopes to cap an astonishing comeback following a seven-month injury lay-off.
"The most important thing for me is that on the toughest surface for me, the most difficult one, I was able to win four matches against top-eight players," Nadal, whose bulging CV is only missing a Tour Finals title, told reporters.
"Now there remains one more match, probably the hardest, and I need to play my best match to have a chance tomorrow."
Federer said: "I went for it when I had a chance for a breakpoint in the first set. Maybe I shouldn't have, but I did. No regrets there, I guess.
"I just struggled to stay consistent enough throughout the match, and that's why he deserved to win. He was better today."
- Sports & Recreation