Watkins, who won the last of his 18 Test caps in the summer of 2006, was still under contract at Stradey Park but found Gloucester's offer "too good to refuse".
The 29-year-old joins England and Bath centre Olly Barkley in agreeing a move to Kingsholm for next season.
Watkins said: "When you talk of massive clubs in England and Europe, Gloucester are right up there and I am very fortunate that I now have the opportunity to test myself with them.
"Their ambition is to be challenging regularly for honours and that is why this move is of such importance to me.
"When the opportunity arose for me to meet with (head coach) Dean Ryan and look at the set-up in place at Gloucester and their outstanding training facilities at Hartpury College, I knew it was simply too good to refuse.
"It is a fantastic opportunity to take my career in a new and fresh direction and I cannot wait to get started."
Gloucester finished top of the regular-season Guinness Premiership table after an attritional 8-6 victory over Bath on Saturday and will host Leicester in the semi-finals this coming weekend.
Ryan insists the Cherry and Whites are still a long way from being the finished article, but he is confident Watkins will help push them further in the right direction.
"At Gloucester we are promoting an environment where players have to fight for their places and Matthew's addition emphasises that," said Ryan.
"I am really pleased he has decided to join us because he was in demand by a number of clubs and for him to choose Gloucester affirms the direction in which we are heading.
"Matthew has a proven pedigree as a top-class outside centre and he will bring experience, big-game expertise and first-class attitude to our squad.
"We believe his addition to the squad will greatly enhance our options and build further on a group that is progressing really well."