"The German economy remains robust," Ifo president Hans-Werner Sinn said in a statement as the closely watched climate index climbed to 106.7 points from 106.2 points in July, marking the highest level since June 2007.
Analysts polled by Dow Jones Newswires had forecast on average a slight decline to 106 points following a record jump by the poll of 4.4 points in July.
The latest improvement fortified the sharp increase seen a month earlier, the biggest increase since German reunification, Ifo said.
The survey was released a day after official data confirmed German output grew by 2.2 percent in the second quarter from the previous three-month period, the biggest quarterly increase since east and west Germany were reunified in October 1990.
The German central bank and most economists now forecast full-year growth of at least 3.0 percent, compared with weaker activity elsewhere in the 16-nation eurozone, Japan and the United States.
"In contrast to sentiment indices in other countries, the Ifo survey has remained at an elevated level, suggesting above-trend GDP (gross domestic product) growth in Germany - growth which is still supported by a favourable labour market situation," Barclays Capital economist Thorsten Polleit said.
German business sentiment has now reached its highest level since before the global financial system was slammed by a meltdown of the US market for high risk mortgages in mid-2007.
Tempering the euphoria, however, Ifo also said business expectations for the next six months edged slightly lower to 105.2 points from 105.5 points a month earlier.
Nevertheless, analysts had expected a bigger drop to 104.9 points.
The institute surveys some 7,000 German manufacturing, construction, wholesale and retailing companies each month to establish its key snapshot of business sentiment.
It found in the manufacturing sector that while the current climate was better than in July, the six-month outlook was "still very confident, though somewhat less so than in the previous month."
Many economists and business leaders expect Germany's strong rebound from a record post-war recession to taper off in the coming months.
But the government is expected to raise its current official forecast of 1.4 percent growth in October in light of strong exports, industrial order books that are still filling up and a pick up in investment and domestic consumption.
"For the time being and for rest of the year, just processing the received orders could be enough to bring annual GDP growth to levels hardly seen since reunification," ING senior economist Carsten Brzeski said.