BERLIN German manufacturing activity shrank for the 10th month running in December, a survey showed on Wednesday, and profit margins stayed under pressure as official inflation figures ticked up.
Germany's economy has outperformed its peers in the euro zone as sovereign debt crises have driven most of its partners to raise taxes and cut spending.
But weak growth and recessions among its closest trading partners have left Germany increasingly dependent on demand from emerging markets elsewhere.
Markit's Purchasing Managers' Index (PMI) for the German manufacturing sector fell to 46.0 from 46.8 in November, undershooting a flash estimate of 46.3 and well below the 50 cut-off line between growth and contraction.
The survey also showed manufacturers unable to raise their prices for the seventh month running.
While they reported some slight easing in their input costs, which fell slightly for the first time in four months, official German data showed higher-than-expected inflation in December, with prices rising an annual 2.1 percent - above the European Central Bank's target ceiling - and 0.9 percent on the month.
"German industry is finding it increasingly difficult to keep production at the same level as at the peak of the recovery phase," said Tim Moore, a senior economist at Markit.
Even so, price trends "should ease the pressure on profit margins at the start of the year and make things a little easier for industrial companies," said Moore.
Economists struggling to interpret mixed data in the last few weeks expect Europe's biggest economy to have contracted in the fourth quarter of 2012 but see an improvement in the first quarter of 2013.
Most participants in the survey blamed weak demand, especially from abroad, and economic uncertainty for the negative trend.
"Manufacturers are reacting to deteriorating demand with price reductions and job cuts," said Moore.
Economist Thilo Heidrich said December's inflation rate increase did not mean an increased threat of inflation and prices should ease in January.
"For the rest of 2013 we expect moderate upward pressure in prices. The inflation rate should, as in 2012, level off at around 2.0 in average for the year," he said.
Euro zone inflation in December is forecast at 2.1 percent on the year, a slight fall from November's 2.2 percent.
The German government and the country's central bank have both hinted they would tolerate higher prices as long as euro-wide inflation remains under control. That could help ailing euro zone countries boost their competitiveness.
(Reporting by Madeline Chambers and Alexandra Hudson; Editing by Ruth Pitchford)