Storm clouds gathered over Europe's top economy Wednesday as eurozone debt fears drove down German business confidence after a ratings agency switched its outlook for the country to negative.
Business confidence in Germany dropped for the third month in a row in July as companies grew increasingly pessimistic about the fallout from the euro area's debt turmoil, data from the Ifo economic institute showed.
Its closely watched business climate index dropped to 103.3 points in July from 105.2 points in June, a slightly steeper decline than analysts had been expecting.
Economists polled by Dow Jones Newswires had pencilled in a drop to 104.5 points this month.
"The euro crisis is having an increasingly negative impact on the German economy," said Ifo president Hans-Werner Sinn.
"The business climate in manufacturing deteriorated significantly. More specifically, manufacturers assessed their current business situation much less favourably than last month."
He said manufacturers were also downbeat about the business outlook although other sectors of Europe's top economy provided some solace.
"Developments in retailing offer a ray of hope, as the business climate indicator continued to rise at this level of trade," Sinn said.
"Retailers assessed both their current business situation and their six-month business outlook more favourably."
The wholesale business climate continued to deteriorate, with a gloomy outlook for future prospects, and the building sector reported serious doubts.
Ifo calculates its headline index on the basis of companies' assessments of their current business and the outlook for the next six months, with 100 being the long-term average.
The sub-index measuring the current business situation fell to 111.6 points in July from 113.9 points in June, while the outlook sub-index dropped to 95.6 points from 97.2 points -- the lowest level in three years.
The news came hard on the heels of Moody's on Monday taking the first step toward stripping Germany of its coveted top triple-A credit rating, cutting the outlook for Europe's largest and economy to "negative" from "stable."
Analysts said the Ifo report confirmed the pessimism.
"July's Ifo index will add to the growing concerns over the health of the German economy," said Jonathan Loynes, chief European economist at Capital Economics.
"The Ifo is not the best indicator of overall economic growth but, on past form, the BCI (business confidence index) points to broadly stagnant GDP (Gross Domestic Product)."
Writing under the headline "Ifo wakes up to reality," Commerzbank analyst Joerg Kraemer said the survey dovetailed with hard data that pointed to growing weakness such as slumping manufacturing orders.
"The risk is rising that (third quarter) German GDP will decline on (second quarter)," he said, adding that the bad news could prompt the European Central Bank to swing into action with a rate cut at next week's board meeting.
ING Belgium's Carsten Brzeski said the latest indicators should be an "urgent wake-up call for the German economy," which is heavily reliant on exports.
"With austerity-driven slowdowns coming now also to most other core eurozone countries, an obvious cooling of the Chinese economy and a still not very dynamic US recovery, order books are emptying and companies have started to reduce stocks," he said.