Unemployment in Germany could, by early next year, rise to 4.2 million, or 10 per cent of the workforce, according to a respected economic institute.

If proved accurate, the estimate, from the Institute for World Economic Research in Kiel, would be a huge blow to the re-election hopes of Chancellor Gerhard Schr÷der.

He promised voters at the last election that his government "didn't deserve to be re-elected" if he failed to cut unemployment to 3.5 million by election time. Last month, unemployment rose to 3.864 million when seasonally adjusted, the seventh consecutive monthly rise. Mr Schr÷der tacitly admitted two weeks ago that he would not achieve his unemployment goal.

Even ordinary Germans are pessimistic about the country's economic future. Some 40 per cent believe the German economy will experience negative growth this year, compared to 14 per cent last year. According to the poll of 7,500 Germans published yesterday, only 23 per cent of those surveyed had an optimistic economic outlook. More than 80 per cent believed that significant social welfare and labour market reforms are needed.

In a newspaper interview, the vice-president of the ruling Social Democrats, Mr Rudolf Scharping, proposed a first step in that direction. He said young people should be given training contracts with an offer of work, and that those who refused be denied unemployment benefit. His proposal has found favour with opposition conservatives, but earned the wrath of trade unions. They argue that employers must be forced to hire new workers by limiting overtime hours worked.

The economic gloom in Germany is expected to continue with the release this week of the influential IFO business climate index for July, followed by the official GDP data for the first half of the year.

Last week, the Bundesbank said it believed growth in Germany had slowed to zero in the second quarter of this year. Meanwhile, an economic institute estimated the German economy contracted in the second quarter, and that annual growth would only reach 0.7 per cent. The only positive economic news to emerge from the federal statistics office concerned Germany's construction sector. New orders rose by 3.6 per cent in June in real terms, compared with the year-earlier period, the first increase in over two years.

But in the six-month period to June, new orders fell 5.1 per cent compared with last year.