German business confidence declined to a three-year low in August, adding to concerns Europe's largest economy may slip into a recession.

The Munich-based Ifo institute's business climate index, based on a survey of 7000 executives, fell to 94.8 from 97.5 in July. Economists expected a drop to 97.2.

Germany's economy contracted in the second quarter and may not grow in the third. While oil prices have receded from a record $US147.27 a barrel, they're still up 60% over the past year, crimping companies' spending power just as the euro's appreciation and the US housing slump weigh on export demand.

"Business confidence will continue to decline,'' said Andreas Speer, an economist at Bayerische Landesbank in Munich. "We're in the middle of a slowdown with a high risk of a recession.''

The economy contracted 0.5% in the three months through June as construction slumped and companies and households reduced spending.

Consumer confidence has dropped to the lowest in more than five years, a report from GfK showed today.

The German government has maintained its forecast for growth of 1.7% this year after 2.5% in 2007.

Still, the Berlin-based BDB banking association said on August 20 that the economy may barely expand in the second half of the year.

Manufacturing and service industries in the 15-nation euro region contracted for a third straight month in August and confidence in the economic outlook last month dropped the most since the September 11 terrorist attacks in 2001.

"The further development in business confidence will hinge on oil prices,'' said Sylvain Broyer, an economist at Natixis in Frankfurt. ``We may escape a recession in 2008, but the threat for next year is still significant.''
 
German investor confidence rebounded from an all-time low this month after oil prices and the euro declined.
 
The price of crude has dropped 6.6% over the past month to around $US115 a barrel. The euro has retreated from an all- time high of $US1.6038 on July 15 to $US1.4679 today. That's still a gain of 8% from a year earlier.

The European Central Bank last month raised its key rate by a quarter of a percentage point to 4.25% to counter inflation even as the economy cools.

With the economic outlook deteriorating, investors have pared expectations for further rate increases, Eonia forward contracts show. The yield on the December contract was at 4.22% today, down from 4.41% a month ago.

Bloomberg