BUSINESS confidence in Germany has fallen to its lowest level for more than two years during the past month, underlining the fragile state of the German economy.

The gloomy results of the widely-followed business survey conducted by the economic research institute, Ifo, were seen as further vindication of the Bundesbank's surprise cut in interest rates on Thursday.

Mr Michael Clauss, an economist at investment bank CSFB, said: "Interest rates will have to stay very low for the foreseeable future. There must be no risk that they will go up."

The Bundesbank's action, ahead of Sunday's meeting of G7 finance ministers in Washington, makes plain its concern about the state of the economy.

It hopes the half-point reduction in the discount rate to 2.5 per cent, matching its all-time low, would help both by lowering long-term interest rates and by bringing down the D-mark's value against the dollar and sterling.

The central bank has engineered the right conditions for these results by signalling that it will reduce the repo rate, its key money market interest rate, during the coming weeks.

Despite the clear signs of slowdown during the past few months, economists were surprised by the scale of the decline in business sentiment last month. The Ifo index for the former West Germany fell for the fourth month, from 91.8 to 90.4, the lowest since December 1993. The index for the former East Germany fell from 102.4 to 100.5.

"It is surprising to see confidence falling in spite of better retail conditions and the monetary easing we have seen," said Mr Julian Callow of Kleinwort Benson. He said it was a signal of the depth of the problems facing German industry.

On top of structural problems such as high labour costs, businesses have been suffering from the strength of the D-mark last year and weakness in Germany's main export markets.

The trade-weighted index for the currency has fallen just over 5 per cent from its early-1995 peak, but export growth has slowed and orders have slumped this year.