There are fears the VAT rise could hit domestic spending

The strong euro and the slowing US economy were likely to hit exports, the organisation said.

Its monthly index fell from 15.1 points in July to minus 5.6 points in its latest survey of 307 analysts and institutional investors.

It had been expected to fall - but the scale of the slump surprised analysts.

Concerns building

Last week Germany said GDP for the second quarter of 2006 had been strong at 0.9%.

But the increase in VAT from 16% to 19% in January 2007 was stirring concerns over a drop in investment and domestic consumption, said Jaspreet Sehmi of the Centre for Economics and Business Research (CEBR).

On Monday, German Chancellor Angela Merkel saluted her nation's growing economic recovery, declaring that Germany was no longer "the sick man of Europe".

Commenting on last week's economic data, which showed the best quarterly growth figures since 2001, she said Germany had "turned the corner".

Reductions in the budget deficit and an upturn in the world economy helped to cut unemployment and boost growth, she said.

The ZEW survey also quizzed investors on their thoughts about the current budget climate, and this index rose 10.3 points to 33.6 points

ZEW president Wolfgang Fritz said this showed investors were holding longer-term concerns.

"The sunny assessment of the business climate in Germany might be justified in 2006, but in 2007 dark clouds will appear on the horizon," he said.