The Munich-based Ifo think tank said on Monday its business climate index, based on a monthly survey of some 7,000 firms, fell to 102.3 in August from a downwardly revised 103.2 in July.

For the first time in three years the majority of firms deemed their export prospects "negative".

A Reuters poll of 40 economists had forecast a fall to 102.6 from an originally reported 103.3.

"German companies are increasingly becoming pessimistic about the future... exports and domestic consumption have shielded the German economy against the euro crisis virus up to now. This immunity, however, has been crumbling away quickly over recent months," said Carsten Brzeski at ING.

"It looks as if the German economy will, at best, be treading water in the coming months. The latest batch of sentiment indicators even points to a contraction in the third quarter," he added.

Growth in Europe's largest economy slowed in the second quarter of this year to 0.3 percent. A string of increasingly gloomy data has raised the possibility of recession in the second half of the year.

That spells particularly bad news for the euro zone economy, which desperately needs Germany - until recently resilient to the crisis - to help haul it out of a slump.

EXPORT FEARS

The decline in the Ifo index reflects companies fears that European export markets are faltering and demand from emerging economies may not be able to pick up the slack.

Uncertainty is also intense at a time when Greece is seeking more time to meet the terms of its bailout and policymakers are scrambling to prevent contagion from enveloping the big economies of Spain and Italy.

"The euro crisis is gnawing away at German growth," said Ifo economist Klaus Wohlrabe. As well as the negative expectations for exports, wholesale and retail expectations also slumped.

"This is down to the general unease, which is becoming more evident," Wohlrabe said.

An Ifo sub-index on current business conditions fell to a more than two year low of 111.2 from a previous 111.6, while business expectations fell to a more than three-year low of 94.2 from 95.6 a month earlier.

Monday's data confirmed what hard data from the Purchasing Managers' Indicator (PMI) already showed last week: Germany's hitherto steady resilience to the crisis is waning.

Orders from abroad for Germany's manufacturing goods, a mainstay for the economy, fell this month at the fastest rate since April 2009.

Industrial flagships ThyssenKrupp (TKAG.DE) and Opel (GM.N) have announced they are reducing working hours due to weaker demand while Bosch ROBG.UL announced it was in talks with workers over shortening hours.

A slowdown carries risks for Merkel as she seeks a third term in office next year and could tie her hands when it comes to bailing out indebted euro zone peers, especially if a nascent rise in unemployment accelerates.

(Reporting by Berlin bureau; Writing by Alexandra Hudson; Edited by Stephen Brown/Jeremy Gaunt)

• A Permanent Economic Emergency