The Ifo think tank's index stood at 103.3, down from 105.2 in June, citing a "significant deterioration" in the manufacturing business climate.
It was the third month in a row the Ifo registered a fall in sentiment.
The news comes shortly after the Moody's rating agency put Germany's top AAA rating on negative outlook, citing risks from the rest of the eurozone.
The German economy is slowing, but the government said it still expected it to grow by 0.7% this year, at a time when much of the rest of the eurozone is in or near recession.
A spokeswoman from the Economy Ministry said the German economy would remain strong: "[The Ifo survey] shows that uncertainty in the eurozone has increased."
"The euro debt crisis raises the risk for our economy as well but at the same time our economy has a high degree of growth and resistance. Our situation is robust."
Germany, the eurozone's largest economy, is also the biggest contributor to its support funds, which have been used to bail out Greece, Ireland and Portugal.
Fears have risen this week that Spain, too, might need similar help.
It has been granted assistance but that is directed at its banks, and does not come with the strict economic monitoring of a full rescue.
Spain's economy minister was visiting his counterpart in France on Wednesday, hard on the heels of a meeting with his German counterpart on Tuesday, which concluded with a joint statement saying that Spain's high borrowing costs did not correspond to its economic strength or the "sustainability of its public debt".
A German finance ministry spokesman said there was no question of Spain seeking a new bailout.
Meanwhile, share and bond markets rose modestly in morning trade on Wednesday, partly in response to hopes that the new eurozone rescue fund, the European Stability Mechanism (ESM) would be given a full banking licence, something that would boost its power.
A European Central Bank (ECB) governing council member, Ewald Nowotny, said that giving the permanent rescue fund a banking licence to increase its capacity had merits.
Such a licence would allow it to exchange the bonds it buys to support indebted countries for fresh cash from the ECB, without needing extra government funds.
But the issue is highly political, with the ECB President Mario Draghi against the idea.
Spain's 10-year bond yield fell to 7.4% on Wednesday, although that is still well above the 7% level at which refinancing is seen as unsustainable.
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