The index rose to 101.6 points in April from 98.2 in March, smashing forecasts by analysts surveyed by Dow Jones Newswires, who were looking for a rise to 98.9 points.
The index has not been so high since May 2008.
"The German economy has shifted into a higher gear," said Hans-Werner Sinn, president of the institute.
The survey of around 7,000 businesses is considered a reliable indicator of future economic performance.
"If the real economy now follows up on confidence indicators' promises, the near future looks very bright," said Carsten Brzeski, an economist from ING.
While a viciously cold winter is expected to have frozen growth in the first quarter of 2010, the economy as a whole is projected to grow by 1.4 percent this year, according to recently published government forecasts.
"Germany is growing again," Economy Minister Rainer Brüderle told parliamentarians earlier Friday.
The country is recovering from its worst recession in more than six decades, with output shrinking by five percent in 2009.
The world's second-largest exporter after China appears to be powering ahead, raising hopes that it could yet drag the rest of Europe with it.
"Neither cancelled flights due to the volcano eruption nor the Greek crisis stopped business sentiment from rising further strongly," said Andreas Rees, an analyst from Unicredit.
"The German business locomotive is currently running at full steam."