The Norwegian Nobel Institute on Friday also praised the "important reforms" that Abiy, Ethiopia's leader since April 2018, has launched at home.
Chairwoman Berit Reiss-Andersen said some people may consider it too early to give him the prize, but "it is now that Abiy Ahmed's efforts need recognition and deserve encouragement."
Abiy, 43, took office after widespread protests pressured the longtime ruling coalition and hurt one of the world's fastest growing economies. Africa's youngest leader quickly announced dramatic reforms and "Abiymania" began.
In a move that caused surprise in the long-turbulent Horn of Africa region, he said Ethiopia would accept a peace agreement with Eritrea, ending one of Africa's longest-running conflicts.
Within weeks, Eritrea's longtime leader, visibly moved, visited Addis Ababa and communications and transport links were restored. For the first time in two decades people could, long-divided families made tearful reunions.
The improving relations led to the lifting of United Nations sanctions on Eritrea, one of the world's most reclusive nations. But Ethiopia's reforms appear not to have inspired any in Eritrea, which has since closed border posts with its neighbor.
At home, Abiy offered one political surprise after another. He released tens of thousands of prisoners, welcomed home once-banned opposition groups and acknowledged past abuses.
People expressed themselves freely on social media, and he announced that Ethiopia would hold free and fair elections in 2020. The country has one of the world's few "gender-balanced"
Cabinets and a female president, a rarity in Africa.
And for the first time Ethiopia had no journalists in prison, media groups noted last year.
The new prime minister also announced the opening-up of Ethiopia's tightly controlled economy, saying private investment would be welcome in major state-owned sectors - a process that continues slowly.
But while Abiy became a global darling, speaking at the World Economic Forum in Davos, Switzerland, troubles arose at home.
A grenade was thrown at him during an appearance in the capital. A large group of soldiers confronted him in his office in what he called an attempt to derail his reforms.
In a display of the brio that has won Abiy widespread admiration, the former military officer defused the situation by dropping to the floor and joining the troops in push-ups.
Greatest challenge yet
More troubling these days are Ethiopia's rising ethnic tensions, as people once stifled by repression now act on long-held grievances.
Some 1,200 people have been killed and some 1.2 million displaced in the greatest challenge yet to Abiy's rule. Some observers warn that the unrest will grow ahead of next year's election.
Abiy had been among the favorites for this year's prize in the run-up to Friday's announcement, though winners are notoriously hard to predict. The Nobel committee doesn't reveal the names of candidates or nominations for 50 years.
Since 1901, 99 Nobel Peace Prizes have been handed out, to individuals and 24 organizations. While the other prizes are announced in Stockholm, the peace prize is awarded in the Norwegian capital, Oslo.
So far this week, 11 Nobel laureates have been named. The others received their awards for their achievements in medicine, physics, chemistry and literature.
With the glory comes a 9-million kronor (£732,575.93) cash award, a gold medal and a diploma.
Even though the peace prize is awarded in Norway, the amount is denominated in Swedish kronor.