By Kim Mackrael

OTTAWA -- The Canadian economy contracted in October, falling short of expectations as manufacturers recorded their largest monthly decline in output in nearly three years.

Canada's gross domestic product, the broadest measure of goods and services produced in an economy, fell 0.3% in October from the previous month, to 1.68 trillion Canadian dollars ($1.24 trillion), Statistics Canada said Friday. Market expectations were for a flat reading, according to economists at Royal Bank of Canada.

The report comes after a strong reading in September, when Statistics Canada said the economy expanded a revised 0.4% from the previous month. The data agency had earlier estimated a 0.3% gain for September.

CIBC World Markets economist Nick Exarhos said the October data suggest the Canadian economy is poised for a slowdown in the fourth quarter. Even with a rebound in November and December, he said, the economy is likely to expand at an annualized growth rate of just over 1%, below the Bank of Canada's earlier outlook for a 1.5% expansion.

"That's only a modest miss versus the Bank of Canada's forecast, and not enough on its own to prompt a quick rate cut," Mr. Exarhos said in a note. "But it will give teeth to Governor [Stephen] Poloz's warnings that the closing of the output gap -- and any potential tightening -- is still a very distant proposition, with Canada not following in the [Federal Reserve's] footsteps towards higher rates."

October's decline was led by a sharp drop in manufacturing output, which fell 2.0%, marking the sector's largest monthly decrease since December 2013. Statistics Canada said the drop reflected alower volume of manufactured goods exports.

Policy makers in Canada have been repeatedly disappointed by weak non-resource export growth, which the Bank of Canada hoped would lead the economic recovery after lower global commodity prices shrank the country's energy sector.

The sharp drop in energy prices have weighed on business investment and the value of the Canadian dollar over the past two years. The Bank of Canada's most recent forecast anticipates growth of 1.1% this year, followed by acceleration to 2.0% in 2017 and 2018.

Many economists expect the central bank to leave its key policy rate at 0.5% for at least another year.

"There's still a lot of slack in the Canadian economy," Desjardins Capital Markets economist Jimmy Jean said. While the firm's expectation is for the Bank of Canada to remain on hold over the long term, Mr. Jean said, October's GDP report makes a rate cut slightly more likely in the new year.Statistics Canada said the mining, quarrying and oil and gas extraction sector, which fell 1.2% in October, also contributed to the month's decline. The drop was led by lower oil and gas extraction, while mining and quarrying expanded in the month.

Economists had anticipated a pullback in October oil and gas extraction after strong gains in earlier months as the sector recovered from spring wildfires in the oil-producing province of Alberta.

Construction, finance and insurance and utilities also fell in October, the data agency said, while higher retail and wholesale trade helped offset some of the overall drop.

Service industries, which account for roughly two-thirds of total Canadian economic output and include wholesale and retail trade, rose 0.1% in the month. Goods-producing industries declined 1.3% in October.

Write to Kim Mackrael at kim.mackrael@wsj.com

(END) Dow Jones Newswires

December 23, 2016 10:30 ET(15:30 GMT)

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