UPDATE 1-German ZEW index drops for third straight month in July
* Euro zone crisis still hurting German business morale
* ZEW says expectations may be bottoming out
* Economists see Germany escaping severe deterioration (Adds quotes, details, background)
By Eva Kuehnen and Sakari Suoninen
MANNHEIM, Germany, July 17 (Reuters) - German analyst and investor sentiment dropped for a third consecutive month in July, a survey showed on Tuesday, providing further evidence that the euro zone crisis is taking its toll on morale in Europe's largest economy.
But the ZEW think tank, which conducts the monthly poll, said expectations may have now hit bottom and that the outlook for the rest of the year should prove stable.
The main reading from the ZEW poll of economic sentiment slid to -19.6 from -16.9 in June, coming in slightly above the median forecast in a Reuters poll of 38 economists for a drop to -20.0.
The index measuring current conditions fell to 21.1, the lowest level since June 2010, and compared with 33.2 last month.
"The latest stock market stabilisation, the ECB's rate cut, the weaker euro exchange rate and lower oil prices have all not succeeded in brightening up German investors," said ING economist Carsten Brzeski.
"(The survey) will clearly add to growing concerns about the strengths of the German economy. However, throughout the financial crisis, the ZEW index has been a euro crisis thermometer rather than a good leading indicator for German growth."
ZEW President Wolfgang Franz said the decline in expectations for the end of 2012 was flattening out gently.
"This could possibly be an early sign of an encouraging development in 2013," he said, but added that the risks should not be underestimated.
"Besides the weak demand from the euro zone for German exports, the German economy is also burdened by weakening growth dynamics in other important partner countries," he said.
ZEW economist Michael Schroeder said he would not be surprised if Tuesday's data had hit the bottom line in terms of expectations.
"Our forecast is until year-end and for this year from now on it is more or less stable. From now on the (economic) development should be stable until the year end," he said.
The German economy put in a relatively strong performance in the first quarter of the year, growing 0.5 percent and saving the euro zone from recession, but recent data has painted a mixed picture.
Purchasing managers' surveys showed the private sector shrank for the second month running in June, pointing to a possible contraction in second quarter gross domestic product, and retail sales also dropped in May, dampening hopes that domestic demand will underpin growth.
German retailers have been feeling the effects of the debt crisis engulfing much of Europe - department store chain Karstadt said on Monday it would cut 2,000 jobs and the chief executive of Metro, the world's No. 4 retailer, said earlier this month the debt crisis was hurting demand.
But German exports and imports both rebounded strongly in May, while industrial orders also rose, fuelling hopes that Germany's economy can remain relatively resilient.
"The economy has not yet escaped the risk of a contraction in the second quarter but a severe deterioration, as in most other euro zone countries, should be avoided," Brzeski said.
The index was based on a survey of 273 analysts and investors and conducted between July 2 and July 16, ZEW said. (Writing by Michelle Martin, editing by Gareth Jones)
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