It’s the first time the Italian have made the final in 12 years, the 2-0 win coming at the expense of host nation Germany.
Hundreds of Italian supporters huddled around giant television screens in cafes and bars along Sydney’s Norton Street, the heart of the city’s Italian district.
When Italy scored two goals in extra time to secure victory their screaming supporters, draped in red, white and green, poured onto the street to party.
The crowd quickly swelled from a few hundred to several thousand as locals joined the celebrations.
Flares and fireworks lit up the sky and orange smoke filled the streets.
Italian supporter Michaela Green says it's like they've already won the World Cup.
There were similar scene in Melbourne's Lygon Street where Azzuri fans celebrated into the morning.
Chanting "Italia", banging drums and waving flags, more than 400 fans spilled out of cafes in Lygon Street, Carlton, stopping peak-hour traffic.
Extra-time goals
Normal time had failed to produce a goal in the semi-final clash and it looked like penalties were on the cards as both teams battle for the points in extra-time.
But Italian defender Fabio Grosso scored deep with about 90 seconds left on the clock with a brilliant curling effort, then substitute Alessandro Del Piero added a second to break Germany's hearts.
Del Piero, who has so often failed to produce his abundant talent for the Italians, was understandably emotional.
"We came up against a very strong opponent," said the 31-year-old Azzuri. "But we showed that we had the will power to beat them.
Grosso was almost lost for words at scoring in such an important match.
"I am drunk with joy, I haven't got much to say only that it is a victory for a strong group of people," said the 28-year-old Palermo defender.
Italy’s coach Marcello Lippi said his side had deserved it. "It was tough but we are delighted that we have done it." said the 58-year-old.
"It is a dream we have achieved something huge here. If either side deserved to win it then it was us. It's a really special moment, fantastic. I was so impressed with the enthusiam and the effort from my team and I am so proud of the boys."
Italy, who won the last of its three titles in 1982 beating West Germany 3-1, will face either France or Portugal in Sunday's final at Berlin's Olympic Stadium.
For Germany a third place play-off in Stuttgart on Saturday will be little consolation.
Germany had never lost in Dortmund but Italy produced its best display of the tournament to reach the final.