German business sentiment rose sharply in December, defying expectations for a decline and underscoring the resilience of Europe's dominant economy in the face of a sovereign debt crisis that has hammered euro zone growth.

The Munich-based Ifo think tank said on Tuesday that its business climate index, based on a monthly survey of some 7,000 companies, rose to 107.2 in December from 106.6 in November, posting its biggest monthly rise since February.

It was the second rise in a row after an equally surprising gain in November. Economists surveyed by Reuters had forecast a drop to 106.1.

Analysts welcomed the rise but took care not to overplay its significance, particularly in the wake of recent downbeat German export and manufacturing data, and amid continuing downward revisions to 2012 economic growth forecasts.

The small rise in the December's Ifo index is a welcome surprise but hardly transforms the outlook for the economy, said economist Jonathan Loynes at Capital Economics.

All of the indices are still sharply down on their summer readings ... Overall, there is some encouragement here that the German economy is not currently plunging into recession, but the picture is one of very weak growth at best, he added.

News of the data helped the under-pressure euro strengthen to $1.3125. It also spurred a rebound in European stocks, following a slide of 4.3 percent over the last fortnight.

The German economy seems to be successfully countering the downturn in Western Europe. This bodes well for Christmas, Ifo President Hans-Werner Sinn said in a statement.

SLOWDOWN, BUT NO SLUMP?

The survey's coordinator, Klaus Abberger, noted the business climate in retailing and domestic construction had improved.

At the moment I don't think we (Germany) will fall into recession again, he said.

The business expectations sub-index proved particularly strong, rising to 98.4 from a previous 97.3, the biggest gain since July 2010, and well in excess of a forecast for 97.0.

The figures dovetailed with data from the GfK institute released earlier on Tuesday showing consumer morale held steady going into January, bucking expectations for a fall, as income expectations and views of the economy improved.

Domestic demand helped the German economy grow a healthy 0.5 percent in the third quarter, but investor morale has since soured as a convincing solution to the euro zone debt crisis remains elusive, fuelling expectations of a slowdown going into the new year and depriving the euro zone of its key growth motor.

Three think tanks cut their 2012 forecasts for German GDP on Tuesday, with the IMK becoming the first major institute to predict a recession for Europe's bulwark economy.

The main reason for the drastic economic slowdown remains now, as before, the unresolved confidence crisis in the euro zone and the high-profile austerity programs in ever more euro zone and European Union countries, the IMK institute said.

Concerns over Germany's ability to weather the crisis were underlined earlier this month, when a survey showed German manufacturing contracted for a third straight month in December and exports posted their biggest fall in October in half a year.

A survey by insurer Allianz published on Tuesday also gave a negative slant, showing that only 32 percent of those asked in the fourth quarter expressed confidence about the economy in 2012, down 11 percentage points from a year ago.

Confidence had been rattled by the debt crisis and the current economic climate, the study said.

Analyst Rainer Sartoris at HSBC Trinkaus called the Ifo index a forgiving end to the year.

The numbers show confidence that the German economy will not collapse. The first and second quarters of 2012 will be weak, but we expect the German economy to pick up in the course of the year.

(Reporting by Berlin bureau; Writing by Alexandra Hudson; Editing by John Stonestreet)

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