Feb. 24 (Bloomberg) -- German business confidence dropped to a 26-year low in February as the worst recession since World War II prompted companies to curb production and lay off workers.

The Ifo institute in Munich said its business climate index, based on a survey of 7,000 executives, fell to 82.6 from 83 in January. That’s the worst reading since November 1982. Economists expected the index to hold steady, according to the median of 37 forecasts in a Bloomberg News survey.

The International Monetary Fund expects the German economy, Europe’s largest, to contract 2.5 percent this year. German lawmakers last week agreed to more than double the government’s fiscal stimulus to about 80 billion euros ($105 billion) and the European Central Bank has signaled it will cut interest rates to a record low next month, offering hope of a recovery later this year.

“It’s not as bad as it looks,” said Andreas Scheuerle, an economist at DekaBank in Frankfurt. “The main drag is the current conditions component. Expectations on the other hand have improved considerably in the past two months, showing there is hope global policy packages and lower commodity prices will revive the economy in the second half of the year.”

While Ifo’s gauge of current conditions fell to 84.3 from 86.8, the measure of expectations rose to 80.9 from 79.5. The euro rose to $1.2815 from $1.2738 before the Ifo report was published.

Investor Confidence

Germany’s benchmark DAX share index has dropped 20 percent this year, closing at the lowest in more than four years yesterday. Still, German investor confidence jumped the most in more than 15 years this month on hopes for an economic recovery later this year.

Chancellor Angela Merkel’s stimulus program, which includes tax cuts and infrastructure investment, amounts to about 1.6 percent of gross domestic product, making it the biggest spending boost in Europe.

Crude oil prices have also dropped more than 70 percent from a July peak of $147 a barrel, damping inflation and increasing consumers’ and companies’ purchasing power.

The ECB, which has lowered its benchmark lending rate by 2.25 percentage points since early October to 2 percent, is poised to deliver another reduction in March.

Some policy makers’ reluctance to cut rates as aggressively as the Federal Reserve and the Bank of England may be melting as data suggest Europe’s recession could deepen.

Call for Action

“Official interest rates have been lowered; in many countries they are near zero,” ECB council member Mario Draghi said in a speech in Milan on Feb. 21. “Worrying about getting too close to the lower limit for nominal interest rates cannot be a reason for inaction.”

Manufacturing and service industries unexpectedly contracted at a record pace this month, a survey of purchasing managers showed on Feb. 20. The report “challenges our forecast of a stabilization in first-quarter economic data,” Royal Bank of Scotland economists wrote in a research note.

European industrial orders declined for a fifth month in December as the global economic crisis reduced demand for machinery and metals, a report showed today.

German car makers Volkswagen AG, Bayerische Motorenwerke AG and Daimler AG are among companies that have scaled back production and employment as the global slump saps demand.

Plant and machinery makers will reduce output by 7 percent this year and cut as many as 25,000 jobs, the VDMA industry association said Feb. 10. Heidelberger Druckmaschinen AG, the world’s largest printing press maker, has said it wants to cut 2,500 jobs to save money.

“The reality is sinking in that a recovery may take a lot longer than initially anticipated, even with all the stimulus packages,” said Kenneth Broux, an economist at Lloyds Banking Group Plc in London. “As an export nation Germany depends on the global economy, and that will remain very weak.”

To contact the reporter on this story: Gabi Thesing in Frankfurt at gthesing@bloomberg.net

Last Updated: February 24, 2009 05:57 EST