The German IFO index strengthened to 111.0 for December from 110.4 the previous month, which was above the expected reading of 110.7 and the strongest reading since February 2014.
The current conditions index rose to 116.6 from 115.6, also above expectations and the highest level since February 2012, while the expectations index only increased marginally to 105.6 from 105.5.
There was an increase in the trade and industry sector to 14.8 from 13.7, the strongest reading of 2016 as manufacturing confidence also improved with companies expecting output to strengthen over the next few months.
The construction sector continued to strengthen with a fresh post-unification record high as low interest rates provided robust support.
Confidence in the retail sector was unchanged, but the wholesale sector strengthened further to 17.8 from 15.1, which was the strongest reading for close to three years.
Underlying confidence in the short-term German outlook is likely to remain strong with positive fundamentals. The weak Euro has further boosted German competitiveness in global markets, especially in the US, which will boost the outlook for exports. Monetary policy is also very accommodative with negative real interest rates, which will have a positive impact on domestic demand and underpin the manufacturing sector.
There was little market reaction to the data as EUR/USD maintained a corrective tone just above 1.0460. Bunds remained in positive territory on the day, extending gains after the data, while the DAX index recovered initial losses to trade slightly higher on the day.