Git Merge Conflict - Remote File Deleted, Local File Changed

Try using the --force parameter:

git rm --force <file>

If you want to keep the file in filesystem:

git rm --cached <file>

I tried git rm path/to/file but it says file: needs merge

You will no longer see that error message with Git 2.23 (Q3 0219, seven years later)

"git rm" resolving a conflicted path used to leak an internal message"needs merge" before actually removing the path, which was confusing.
This has been corrected.

See commit b2b1f61 (17 Jul 2019) by Junio C Hamano (gitster).
^{(Merged by Junio C Hamano -- gitster -- in commit 5e9d978, 25 Jul 2019)}

rm: resolving by removal is not a warning-worthy event

When resolving a conflict on a path in favor of removing it, using "git rm" on it is the standard way to do so.
The user however is greeted with a "needs merge" message during that operation:

$ git merge side-branch$ edit conflicted-path-1$ git add conflicted-path-1$ git rm conflicted-path-2conflicted-path-2: needs mergerm 'conflicted-path-2'

The removal by "git rm" does get performed, but an uninitiated user may find it confusing:
"needs merge? So I need to resolve conflict before being able to remove it???"

The message is coming from "update-index --refresh" that is called internally to make sure "git rm" knows which paths are clean and which paths are dirty, in order to prevent removal of paths modified relative to the index without the "-f" option.

We somehow ended up not squelching this message which seeped through to the UI surface.

Use the same mechanism used by "git commit", "git describe", etc. to squelch the message.