Oct. 30 (Bloomberg) -- Canada’s economy unexpectedly shrank in August, suggesting it may not have followed the U.S. out of a recession in the third quarter as the central bank and a majority of economists predict.

Gross domestic product fell 0.1 percent in the month, as oil and gas extraction dropped 2.3 percent and manufacturing fell 0.7 percent, Statistics Canada said today from Ottawa. Economists expected a 0.1 percent increase after output was little changed in July, according to the median estimate of 23 analysts surveyed by Bloomberg.

“There is still hope yet for the third quarter, but boy, August was a disappointment,” said Eric Lascelles, chief economist and strategist at TD Securities Inc. in Toronto.

Governor Mark Carney has said a recession ended in the July-September period after three quarters of contraction, predicting a 2 percent annualized expansion. He plans to keep the benchmark lending rate at a record low 0.25 percent through June 2010 unless the inflation outlook shifts, and warned he may have to act to prevent a strong currency from further slowing growth and inflation.

Canada’s currency and stocks dropped after the report. The dollar fell 1.7 percent to C$1.0845 per U.S. dollar at 4:21 p.m. in Toronto, from C$1.0665 yesterday. The currency has gained 12 percent this year. The Standard & Poor’s/TSX Composite Index declined 164.47 points, or 1.5 percent, to 10,910.75.

Surprise Contraction

The surprise August contraction follows reports that the U.K. economy unexpectedly shrank in the third quarter, while the U.S. grew at a 3.5 percent pace.

Lascelles was one of six economists surveyed to predict a contraction today, and said the quarter may still show expansion because recent monthly figures have been “poor at translating” into quarterly rates.

The economy would have to grow 2 percent in September to generate the central bank’s third-quarter growth prediction, Jonathan Basile, at Credit Suisse Holdings Inc., and Derek Holt at Scotia Capital, wrote in notes to clients.

Oil and gas extraction shrank as production slowed in eastern Canada, while manufacturing declined on drops in output of primary metals, machinery and paper, Statistics Canada said. Factory production has fallen 15 percent since August 2008.

Stimulus Links

“We continue to face volumes that are below last year, though sequential quarter-over-quarter improvements in some sectors have occurred,” Kathryn McQuade, chief financial officer of Canadian Pacific Railway Ltd., said on an Oct. 27 earnings call.

Most of the industries that showed gains in August are linked to government spending, tax cuts and interest-rate reductions. Public administration rose 0.6 percent, retailing rose 0.3 percent and construction rose 0.2 percent, the report said.

Federal and provincial governments are tallying record budget deficits to boost demand. Finance Minister Jim Flaherty told reporters in Toronto today the report shows the recovery is “fragile.”

There is a “lack of evidence of entrenched private demand,” Flaherty said, adding he will keep adding stimulus “until we see clear evidence of resilient private demand.”

The country’s labor market and Statistics Canada’s leading economic indicator suggest the economy is rebounding. The jobless rate fell to 8.4 percent from 8.7 percent in September as employers added 30,600 staff, Statistics Canada said Oct. 9. The agency’s leading indicator index increased 1.1 percent in September, the fourth straight gain.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.

Last Updated: October 30, 2009 16:34 EDT