Output fell 2.6 percent from the previous month according to seasonally adjusted figures provided by the economy ministry, following a gain of 0.7 percent in November and a drop of 1.7 percent in October.
On an annual basis, the fall in December was 7.1 percent, and along with fears over eurozone debt levels, the news helped pushed the euro to a nine-month low of $1.3648 on foreign exchange markets.
Analysts polled by Dow Jones Newswires had expected a rise of 0.5 percent but instead, Germany suffered its steepest fall since February 2009 when the country was mired deep in its worst recession since World War II.
Heavy slumps were seen in the manufacturing and construction sectors, the ministry said in a statement, with only consumer goods production posting an increase.
In general, "industrial production lost momentum" at end of 2009, it said, while forecasting a "downward trend" for the sector in light of the latest industrial orders numbers.
On Thursday, the ministry reported that orders lost 2.3 percent in December as global uncertainty weighed on foreign demand for German goods.
For the entire 16-nation eurozone, the European Central Bank warned Thursday that "the recovery process is likely to be uneven and the outlook remains subject to uncertainty."
Morgan Stanley economist Elga Bartsch said Friday: "We would expect consensus (eurozone) growth forecasts to come down on the back of this report" from Berlin.
Germany accounts for one-third of eurozone output and saw its economy contract by five percent in 2009. With consumption and exports slowly recovering, the government has forecast growth of 1.4 percent this year.
Germany lost its crown as the leading global exporter to China in 2009 however, and the data released Friday implied feeble German industrial output in the last three months of the year.
But "looking ahead, the weak fourth quarter should be a temporary halt rather than the end of the rebound," ING senior economist Carsten Brzeski said.
"It was just one of these painful reminders that recoveries never follow a straight line."
Encouragement might also come from the Organisation for Economic Cooperation and Development, which said Friday its composite leading indicators in December gave "stronger signals of an expansion in economic activity" worldwide.
Winter weather could still hamper a German recovery, Brzeski acknowledged, but "while the snow will eventually melt away, the industry-led recovery should stay."