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By Dave Graham
BERLIN, May 25 (Reuters) - German corporate sentiment rose for a second straight month in May, fuelling hopes that Europe's largest economy is exiting a record slump but also underscoring the weakness of current business conditions.
The Munich-based Ifo institute's business climate index,
based on a monthly poll of some 7,000 firms, rose by less than
expected to 84.2 from 83.7 in April. A Reuters poll had forecast
the headline figure would reach 85.0.
The expectations component of the index rose for the fifth month in a row, but a separate measure of current conditions slumped to its lowest level since German reunification in 1990.
Markets reacted with disappointment to the below-forecast Ifo figure, with the euro falling to its lowest level of the day against the dollar and European shares extending losses.
Economists voiced cautious optimism about the report, which landed less than a week after a separate gauge of analyst and investor sentiment from the ZEW economic institute rose to a three-year high.
"This is a further clear signal that the German economy's tailspin has ended," said Commerzbank economist Joerg Kraemer.
"The recession has lost its velocity. It could even be over by the autumn. But on the other hand no one should overestimate the strength of the upturn," he added. Forward-looking indicators in recent weeks have suggested the pace of the downturn -- which the government has forecast will cause the economy to shrink by six percent this year -- has eased since a record contraction in the first quarter.
In addition to the strong rise in the ZEW index, a flash estimate for Markit's composite purchasing managers index (PMI) for Germany rose to a seven-month high last week.
CAUTION WIDESPREAD
Despite warnings from a number of seasoned observers of the economy that the recent upturn in sentiment should not be taken as evidence of a sustained improvement in the outlook, some firms have already begun to ratchet up their expectations.
German wind turbine maker Repower
A breakdown of the latest Ifo figures showed the outlook for manufacturers remained weak, but had stabilised. Sentiment among wholesalers and retailers improved, although the construction sector was more pessimistic than in April. [ID:nBAE001655]
Nevertheless, employers in Germany's building trade were confident enough about business to agree at the weekend that the sector's 700,000 workers should receive two staggered pay rises for this year and next, each of 2.3 percent.
However, caution remains widespread among analysts.
Timo Klein, an economist at Global Insight, said the coming months were likely to be characterised by a slowdown in the pace of contraction from a first quarter decline in gross domestic product (GDP) of 3.8 percent -- a record in modern Germany.
"A sustained return to positive quarterly GDP growth still appears unlikely ahead of mid-2010, when massive fiscal and monetary policy measures at home and abroad can be expected to unfold their biggest impact," Klein said.
Uwe Angenendt, an economist at BHF-Bank, said the picture remained unstable and that a relapse was not impossible.
"It can't be ruled out that we're seeing an expectations bubble, given the dimension of the current crisis," he said. (Additional reporting by Noah Barkin, Kerstin Gehmlich, Sarah Marsh and Erik Kirschbaum; Editing by Toby Chopra)