By Zahra Hosseinian
But analysts say Khatami's withdrawal will boost hardline President Mahmoud Ahmadinejad's chances of re-election.
Khatami, Iran's most liberal president since the Islamic revolution in 1979, was considered the main pro-reform challenger to Ahmadinejad who succeeded him in 2005.
Khatami said he would back moderate candidate Mirhossein Mousavi.
"I announce my withdrawal from candidacy … to preserve unity among the reformist front and to avoid a split of votes," Khatami said in a statement published on Tuesday, confirming comments to Reuters by his allies on Monday.
The outcome of the June election could influence Iran's approach in its standoff with the West over its nuclear programme, even though Supreme Leader Ayatollah Ali Khamenei has the final say on such issues.
Khamenei has publicly praised Ahmadinejad and analysts say the fate of the presidential election could depend on whether Ahmadinejad retains the support of Khamenei, whose words could influence millions of loyalists.
Khatami, who served from 1997 to 2005, oversaw a thaw in Iran's ties with the West. Those relations have since sharply worsened under Ahmadinejad, who is expected to seek a second four-year term in the June 12 vote.
Mousavi, prime minister during the 1980-88 Iran-Iraq war, and reformer and former parliament speaker Mehdi Karoubi, have both announced they will run. Ahmadinejad is so far the only leading conservative to let it be known that he will stand.
"I believe … Mousavi has the necessary competence to change the current situation," Khatami said.
"Despite differences in our opinions and actions, the important thing is that (Mousavi) … seriously defends and will defend the fundamental rights and freedoms (of people) and … the country's international reputation."
Karroubi switched to the reformist camp during the eight-year presidency of fellow cleric Khatami but he sometimes buckled to pressure from Iran's hardline religious establishment, which blocked Khatami's reforms.
Some political analysts say many Iranians do not regard Mousavi, a former conservative, as a reformist because he does not believe in western-style economic and political reforms.
"Compared to Ahmadinejad, Mousavi is a moderate figure because he believes in press and individual freedoms," Saeed Laylaz, editor of the Sarmayeh business daily, told Reuters.
"Those who wanted to vote for a reformist candidate will not vote for Mousavi. Khatami's decision will boost Ahmadinejad who has his loyal voters."
Ahmadinejad's critics say his vitriolic condemnation of the West has isolated the Islamic state, which Washington and its European allies fear is seeking nuclear weapons covertly. Tehran denies the charge.
(Additional reporting by Parisa Hafezi; Editing by Samia Nakhoul)
