Stronger employment should boost consumption and help the government reduce its deficit faster than anticipated, the Bundesbank added as growth by other major economic powers like China and the United States slows down.
More than half the decline in German production that stemmed from the global economic crisis has now been made up due to favourable conditions both at home and abroad, the central bank said in its monthly report for August.
In 2009, the German economy contracted 4.7 percent, its worst recession since World War II. This year could see the strongest expansion since 2006 however, the central bank said in its monthly report for August.
In the second quarter, the economy expanded by 2.2 percent from the previous three-month period for the strongest quarterly increase since the country was reunified in late 1990.
"The outlook for the current year remains favourable, even if there are signs for a slowing of global production activity and trade," the report said.
"The overall trend of the German economy is positive and the upswing ought to continue," it added, citing increasing investment by domestic firms and growing private consumption.
Meanwhile, there was only a low risk of a second recession in the United States, the report said. US business investment has started to pick up faster than during previous recoveries, which should also underpin employment and consumption, the report said.
US business investment has started to pick up faster than during previous recoveries, which should also underpin employment and consumption, it said.
The World Bank forecast in June that the US economy, the world's biggest, would grow by 3.3 percent this year, while number two China was tipped for an expansion of 9.5 percent. Germany was expected by World Bank economists in June to see growth of 1.3 percent.
In Germany, low funding costs are now expected to help keep private sector construction activity on track while the Bundesbank said it saw a gradual start to recovery in the labour market.
The number of short-time German workers was cut nearly in half in the second quarter to 481,000, as a successful state-subsidised scheme to keep workers in their jobs during the downturn is wound down in turn.
"Wage growth is likely to accelerate somewhat next year," Citi economist Jürgen Michels said as unemployment falls further and capacity utilisation rates recover quickly.
Meanwhile, the Bundesbank said the German deficit would probably be "well below five percent" of gross domestic product this year, and that Berlin would reach a ratio of four percent in 2011 and three percent in 2012.
European Union countries are not supposed to run deficits of more than three percent of GDP and work towards balanced budgets in times of economic growth, but many have had to run up their deficits with stimulus programmes.
The German central bank said Germany was not responsible "for other countries' debts or automatic, institutionalised support at the European level," after Berlin was slammed for failing to quickly aid debt-stricken Greece.
The Bundesbank added that German imports from other members of the 16-nation eurozone had increased twice as fast as exports in the first half of 2010, rebutting critics who claim German growth comes at its neighbour's expense.
"European partner countries thus benefit substantially from the strong growth rates of the German economy, which are primarily driven by exports to external markets," the bank said.