The monthly survey of investors in Europe's top economy fell 6.5 points to 7.6 points in April. This was worse than analysts polled by Dow Jones had expected. They forecast a reading of 10 points.
"Two factors may have contributed to this decline. On the one hand, the current boom doesn't leave much room for a further improvement of the current economic situation," said the institute in a statement.
"On the other hand, experts are more and more aware of the risks for the world economy resulting from the events in Japan and in the Arab world," the ZEW added.
The index is now some way below its historical average of 26.6 points.
The economic institute's president, Wolfgang Franz, said that rising oil prices could force the European Central Bank to increase interest rates further, which might in turn further dampen sentiment.
"Despite the positive economic development, considerable risks may result from increasing commodity prices," Franz told news agency AFP.
"These price increases could lead to second-round effects that could then force the European Central Bank to adopt a more restrictive monetary policy," the president added.
On Thursday, the European Central Bank raised interest rates from record lows for the first time since mid-2008, as concerns about inflation outweighed worries over the ongoing eurozone debt crisis.
Nevertheless, the central bank's president, Jean-Claude Trichet, allayed fears that the bank was about to embark on a rate hiking cycle, saying only it would do whatever was necessary to keep rising prices in check.
Carsten Brzeski from ING Bank said global political events were not about to derail Germany's sparkling economic recovery.
"A very strong first quarter looks a certainty," he said. “However, the geopolitical tensions in the Middle East and North Africa, and the disastrous events in Japan have cast doubt on the sustainability of the German recovery.”
"So far, these doubts remain unjustified," he added. “At least in the eyes of market analysts and investors, the German economy seems to be panic-proof.”
Supporting his view, the markets took the ZEW index broadly in their stride Tuesday, with the euro unmoved against the dollar as the figures came out.
But another economist, Heinrich Bayer from Postbank, said the fall in the index was "at the least a warning shot that the economic environment in Germany could be a little rougher in the second half of the year."
The survey came as the German government prepares to revise up its growth forecast for this year from the current level of 2.3 percent. Economy Minister Rainer Brüderle has already indicated output will be stronger than expected.
On Monday, the International Monetary Fund raised its projection for this year to 2.5 percent.
But natural disasters, geopolitical uncertainty and the spectre of higher borrowing costs have hit business confidence.
This was reinforced when the Ifo indicator of business confidence fell last month for the first time since May 2010.