The Brazilian forward will cost the European-chasing Premier League side a reported £30m, eclipsing the £20m paid to sign Adam Webster from Bristol City in 2019.
Pedro has made 109 appearances and scored 24 goals since joining Watford from Fluminense in January 2020.
The 21-year-old scored 11 goals in 35 championship games for Watford this season.
Brighton technical director David Weir said: "Joao has been a long-term target of ours, and he has also attracted a lot of interest from across Europe.
"So, we are delighted to have reached an agreement with a key target for the club ahead of the summer window opening, and it is great for Joao that he can focus on the new season, with his immediate future settled.
"He's a brilliant young talent, technically very good, quick and with an eye for goal. He will complement our existing forward line very well. He also has settled well here, with good experience of both the Premier League and Championship and more than 100 games for Watford."
Watford technical director Ben Manga told his club’s website: “It can be a surprise to no one that Joao Pedro leaves us now for the Premier League.
“Supporters will understand this agreement is right for all involved. This early action allows us to plan an effective transfer window as we seek to build a competitive team for next season.”
Pedro will sign a five-year contract when he moves to the AMEX Stadium at the end of the season.
