MANNHEIM, Germany (Reuters) - German analyst and investor morale sank in June at its fastest rate since October 1998 on worries about the health of the Spanish banking sector and uncertainty over the Greek election outcome, a survey showed on Tuesday.
The main reading from the ZEW think tank's monthly poll of economic sentiment fell to -16.9, undershooting even the weakest forecast in a Reuters poll of 42 economists. The data adds to signs that Germany, Europe's paymaster and growth engine, is beginning to feel the bloc's pain.
The figure plunged from 10.8 in May and came in way below the central forecast of a drop to 4.0, sending the euro lower against the dollar and weighing on European stocks.
"This is a hefty decline. This is an indication that the worsening of the debt crisis and the increasing tensions in Spain are impacting Germany," said Juergen Michels of Citigroup.
"That should strengthen the ECB in its decision to reduce rates in June," he added.
ZEW economist Michael Schroeder said the number of survey participants who expect the ECB to slash interest rates in the next half year had risen but they were still in the minority.
The disappointing figures come after data showed business morale in France, the euro zone's second largest economy, also slipped in June, putting a dampener on the region's prospects. ID:nP6E8FR02Q]
"It has really come as a surprise to me that it is such a huge decline," ZEW's Schroeder said. "This is not just monthly fluctuation, this is really too big a change to be interpreted as that."
He added that falling exports and slowing growth in Europe and Asia had contributed to the decline.
"The financial market experts' expectations are a strong warning against a too-optimistic assessment of Germany's economic perspectives in the remainder of this year," said ZEW President Wolfgang Franz.
"The risks of a pronounced decline in economic activity in countries with close trade ties to Germany are very clear," Franz added.
He described the situation in the euro zone as "precarious", even after Greeks voted narrowly for parties supporting the terms of its bailout program, saving the country from bankruptcy and a potential exit from the euro.
ZEW's Schroeder said he did not expect Germany to fall back into recession but that Europe's largest economy would experience slow growth. He pointed to the poor outlook for the next half year, especially in the banking and insurance sectors.
"You can't exactly translate a negative figure in expectations into negative growth," he said.
The German economy steamed ahead early in the year and managed to save the euro zone from recession by growing 0.5 percent in the first quarter, but recent data has indicated that it is succumbing to the effects of the region's debt crisis.
Figures released earlier this month showed that German imports tumbled at their fastest rate in two years in April and exports fell more than expected.
The industrial sector is also suffering, with orders posting their sharpest decline since November 2011 in April as contracts from abroad dried up. Industrial production dropped more than expected in April.
Purchasing Managers Index (PMI) surveys due on Thursday are expected to add to the negative mood, with the headline composite index that combines manufacturing and services seen pointing to a contraction in the private sector for the second month running.
But economists said there was still hope on the horizon, and several German research institutes have recently raised their 2012 growth forecasts.
Many expect private consumption in particular to be the economy's saving grace as Germans benefit from low unemployment and higher pay in the chemical and engineering sectors following successful wage negotiations.
"Towards the end of the year, we expect Germany's economy to grow again and help drag the rest of the euro zone out of recession," said Christian Schulz of Berenberg Bank.
The ZEW index was based on a survey of 274 analysts and investors conducted between May 29 and June 18.
Around 30 of the results were collected after Greeks gave pro-bailout parties a narrow majority in Sunday's election but these were only slightly better than responses collected before Greece went to the polls, ZEW's Schroeder said.
(Writing by Michelle Martin; Editing by Catherine Evans)