Steep drop in German industrial output raises spectre of slowdown

German industrial output posted its steepest drop in a year in August, suggesting Europe's largest economy may be losing momentum just as an emissions scandal at Volkswagen casts a cloud over manufacturing.

The 1.2 percent drop announced on Wednesday defied expectations for a small rise and followed a sharp decline in August industrial orders data on Tuesday.

While the Economy Ministry blamed the weakness partly on the large number of summer holiday days in the month, ING economist Carsten Brzeski said it was likely to fuel speculation about whether a slowdown in China was leaving its mark.

"German industry is still struggling to gain momentum. Yesterday's drop in new orders already signalled a note of caution," he said.

Brzeski noted, however, that German industry also posted disappointing numbers last summer and said it remained to be seen whether this was the start of a downward trend or a temporary blip.

Output declined across all sectors in August, except for intermediate goods where production was flat.

Commerzbank economist Ralph Solveen said the late summer holidays in many German states would have played a role.

"Nonetheless, even without this effect the trend for industrial production in recent months has pointed only sideways," Solveen said.

The data contrasts with other recent indicators. Business morale rose for the third month in a row in September, while the private sector continued to expand, albeit at a slower pace.

But industrial orders fell 1.8 percent in August, pointing to waning demand from abroad, especially China and other emerging markets.

The diesel emissions scandal at Germany's biggest car maker Volkswagen could further hurt the sector and the "Made in Germany" brand.

Germany's auto industry accounts for roughly one in five jobs. It accounted for 17.9 percent of Germany's 1.1 trillion euro (£816 billion) in exported goods last year, according to Deutsche Bank, and has enjoyed above-average export growth since 2009.

NORD/LB analyst Mario Gruppe said the fallout from the scandal could weigh on production volumes in the coming months.

"Although it's hard to make any serious forecasts for how sales will develop following the latest announcements, it will be difficult to avoid certain dampening effects," Gruppe said.

"It remains to be seen how far the reputational damage will radiate onto other car companies."