ORA-38104: Columns referenced in the ON Clause cannot be updated

Contrary to the accepted response, there is actually a way to pull this off: move the offending bit out of the ON clause and into the WHERE clause of the update statement:

merge into ET.PSEUDODELETETABLE TARGET
using (select 1 as ID, 'Horst' as NAME from sys.dual) SOURCE
on (SOURCE.ID = TARGET.ID)
when matched then
  update 
      set ISDELETED = 0, 
      NAME = SOURCE.NAME
  where TARGET.ISDELETED = 1 -- Magic!
when not matched then
  insert 
      values (SOURCE.ID, SOURCE.NAME, 0);