What is causing this?
 

Before replacing oil pres. sending unit the guage at hot idel would sit on O at idel, in gear. Just replaced the sending unit and now the needle at idel, in gear fluctuates between 1bar and 1.5 bars. Could this be the connection at the sending unit or the oil guage in the dash?

Between 1 and 1.5 bar at idle is normal.

I would think that if you are able to notice a fluctuation in the oil pressure gauge than you may have a surging idle issue. If you are able to notice your tachometer changing by more than 75 RPM's, try reconciling that issue before proceeding further.
:)

Idel is steady, and the tachometer does not move at all. I don't understand how a mechanical pressure sensor measures pressure and converts it into an electrical value at the dash guage.This problem started after i replaced the sensor.

Consider it a variable resistor, as pressure chages so does the resistance, the gauge reflects that change accordingly. Have you tried changing the oil since the pressure sensor was installed? A new filter with fresh oil might make the difference. If that does not resolve the flutuations completely you can always try another sender and see how it responds, could just be a bad sender.

FYI: You mustn't discount the new item just becuse it is new!

Mrcjames:I got the sensor from fastlane and replaced oil and filter at the same time. BTW i went from 10w 40w to 20w50w

In California (SF Bay area) I have always run 15w40 in everything and have never had difficulties. Personally I have avoided using 20w50 in MB V-8s as I do not feel it is neccessary for the driving conditions, at least in my area.

If the gauge is that erratic you can try switching grades to see if that improves the situation.