Canada’s economy contracted by 0.3% in August, a turnaround from the growth of 0.7% seen in July, Statistics Canada said today.

Wholesale trade, manufacturing, and the energy sector, which were the big contributors to the July increase, all retreated in August, the federal government agency said.

Some transportation industries, such as rail and truck transportation, were also affected by the downturn.

Economists had been looking for an August decline of 0.4%.

The milder than expected drop was largely thanks to a more modest drop in the service sector than expected, according to CIBC World Markets senior economist Avery Shenfeld. “It’s the domestically oriented service sector that is standing in the way of a clear recessionary trend,” Shenfeld commented.

Output of the energy sector decreased 0.5% in August after increasing 2.7% in July, which accounted for a large part of the July growth in total economic activity, StatsCan said. Petroleum and natural gas extraction both declined and the pipeline transportation of natural gas dropped significantly.

Output of refineries declined 4.5%, partly as a result of production disruptions at two major plants.

Wholesaling dropped 3.1% in August, more than offsetting its July gain. A significant decrease in the wholesaling of automotive products accounted for about three-quarters of the drop.

The manufacturing sector fell 1.1% in August, erasing its July gain. The decrease was broadly based, with 18 of the 21 major groups declining.

Dawn Desjardins, assistant chief economist at RBC Economics Research expects third quarter GDP growth to be 1.5%, down from RBC’s previous projection of 2.5% growth for the quarter.

“Even at this slower pace, we still think it is likely that the third quarter will mark the high-water mark for growth this year with financial market stress through the autumn keeping the cost of capital high and the U.S. economy likely having slipped into recession,” Desjardins wrote.

Impacts of the credit crunch will be felt more acutely in the fourth quarter, according to CIBC’s Shenfeld. “We look for a roughly 2% real GDP drop in the final quarter of 2008, with roughly zero growth in Q1.”

IE