The decline in morale stems from weaker demand for German goods and services in China, the euro zone and emerging markets, from transatlantic trade tensions and also growing uncertainty linked to Britain's looming departure from the European Union.
"Disquiet is growing among German businesses," said Clemens Fuest, president of the Munich-based Ifo economic institute. "The German economy is experiencing a downturn."
Ifo said its business climate index fell to 99.1, the lowest level since February 2016.
The German economy grew at a slower pace last year than in 2017 and sources told Reuters on Friday that the government had cut its growth forecast for this year to 1.0 percent from 1.8 percent.
"The increasing danger of a hard Brexit has proved to be a mood-killer," Bankhaus Lampe economist Alexander Krueger wrote in a note. "This is mainly a reflection of falling expectations, which is not surprising given it is also the result of global trade disputes."
Krueger added that the economy, which is expected to gain impetus from private consumption and increased state spending, was still a long way from experiencing a recession.
'ONE BLACK EYE'
But the downturn will continue in the coming months and any improvement will largely hinge on the outcome of Brexit and the easing of trade tensions between the United States and China, both key markets for German exporters.
The manufacturing sector started showing signs of weakness last year as the trade tensions between the United States and China escalated. The downward trend in the sector appears to be dragging down the whole economy.
The German economy has also suffered from homemade factors such as stricter emission standards that created bottlenecks in new car registrations and low rainfall that hampered fuel deliveries that rely on water channels in Germany.
ING Diba economist Carsten Brzeski said that an economic recovery in Germany largely depends on the outcome of Brexit and whether trade tensions dissipate.
"In this regard, Brexit is probably the single most threatening risk as a 'no-deal' Brexit would come at the most inconvenient time for the economy, namely exactly when it should be about to rebound," he added.
Britain, the world's fifth biggest economy and the second largest in the EU, is due to leave the EU on March 29 but its deeply divided parliament has yet to agree on the terms of its exit, raising the risk of a disruptive no-deal Brexit.
"All in all, we still think that the German economy could get away with one black eye. However, the shield that stronger domestic demand can offer against external risks will be put to a severe test in the coming months," said Brzeski.
(Writing by Joseph Nasr; Additional reporting by Michael Nienaber in Berlin and Joern Poltz in Munich; Editing by Gareth Jones)
By Joseph Nasr and Rene Wagner
