Oct. 23 (Bloomberg) -- German business confidence rose to a 13-month high in October, improving the outlook for growth in Europe’s largest economy.

The Ifo institute in Munich said its business climate index, based on a survey of 7,000 executives, rose to 91.9 from 91.3 in September. That’s the highest reading since September last year. Economists expected a gain to 92, according to the median of 40 forecasts in a Bloomberg News survey. The index reached a 26-year low of 82.2 in March.

The government, which is spending 85 billion euros ($127 billion) to haul Germany out of its worst recession since World War II, last week raised its economic forecasts, predicting growth of 1.2 percent in 2010 after a contraction of 5 percent this year. A separate report today showed the country’s manufacturing industries expanded in October for the first time in 15 months. Rising unemployment, the euro’s increase against the dollar and the expiry of stimulus measures may temper the recovery next year.

“Second-half growth data will be robust,” said Luigi Speranza, an economist at BNP Paribas in London. “But the outlook for 2010 remains fragile. Unemployment is likely to keep edging higher and wage growth lower, which should prevent a significant improvement in consumer demand.”

Ifo’s gauge of the current situation increased to 87.3 from 87.1. An index of executives’ expectations advanced to 96.8, the highest since May 2008, from 95.7.

U.K. Recession

Data across Europe today showed some economies are recovering better than others. While French consumer spending rose in September for the first time in three months, the U.K. statistics office said gross domestic product unexpectedly dropped 0.4 percent in the third quarter, keeping its economy mired in recession.

Germany’s manufacturing sector returned to growth in October after 14 months of contraction, a survey of purchasing managers by Markit Economics showed. Service industries expanded for a third month, the PMI report showed.

“We’ve seen an improvement in expectations mainly in the manufacturing industry,” Ifo economist Gernot Nerb said in a Bloomberg Television interview. “To some extent a better export outlook has helped. In the longer run I think the exchange rate could cause problems.”

Euro Strength

The euro has appreciated 20 percent against the dollar since mid-February and reached a 14-month high of $1.50 this week, eroding export returns. It was little changed at $1.5030 after the Ifo report was released.

Volkswagen AG, Europe’s biggest carmaker, predicts the worldwide automotive market won’t match pre-recession levels until 2013 at the earliest. “There are growing signs that the worst of the crisis may now be behind us, but it will take time for the markets to recover,” Chief Executive Officer Martin Winterkorn said on Oct. 8.

In addition to the emergency stimulus measures, Chancellor Angela Merkel’s Christian Democrats are prepared to cut taxes by 20 billion euros after they form a coalition government with the Liberal Democrats, negotiator Steffen Kampeter said on Oct. 16.

“The economy still is on a drip but will return to sustainable growth next year,” said Carsten Brzeski, an economist at ING Groep NV in Brussels, who expects overall output to expand by 2 percent in 2010. “We haven’t seen the election effect so far and the support measures taken are also designed to spur private investment.”

ECB Rates

The picture remains mixed. While German factory orders rose for a sixth month in August and industrial output gained, exports unexpectedly fell. Investor confidence declined for the first time in three months in October amid concerns the recovery could falter.

The European Central Bank has cut its benchmark interest rate to a record low of 1 percent and is lending banks as much money as they want for up to a year in an effort to get credit flowing through the economy of the 16 nations sharing the euro. President Jean-Claude Trichet has said it’s too early to withdraw monetary policy stimulus.

To contact the reporter on this story: Christian Vits in Frankfurt at cvits@bloomberg.net

Last Updated: October 23, 2009 05:21 EDT