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WRAPUP 2-Slump in August imports shows soft Canadian economy

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* Imports fall by a surprising 3.1 percent * Canada blames Europe, U.S. economies for falling revenues * Few see Q3 economic growth meeting Bank of Canada forecast By David Ljunggren

OTTAWA, Oct 11 (Reuters) - Canada's imports in Augustdropped by a surprising 3.1 percent from July, suggesting theCanadian economy is struggling to cope with weak internationalmarkets and slowing domestic demand.

The fall in imports reported by Statistics Canada onThursday overshadowed a bigger drop than expected in the tradedeficit, to C$1.32 billion ($1.35 billion) in August from arecord C$2.53 billion in July. Exports slipped by 0.1 percent.

The trade deficit, the fifth in a row, was smaller than theC$1.90 billion shortfall predicted by market analysts.

The value of imports fell to C$38.79 billion on widespreaddeclines in every sector except energy, while volumes were down2.2 percent. It was the largest month-on-month fall in importssince the 4.4 percent drop recorded in May 2009.

"That's the big story here. The drop in imports was broadlybased and could signal weakness in the domestic economy both interms of soft consumption and weak business investment," saidScotia Capital economists Derek Holt and Dov Zigler.

"That would fit concerns regarding business confidenceheading into a highly active global events calendar includingthe U.S. fiscal cliff," they said in a note to clients.

The "fiscal cliff" refers to the combination of spendingcuts set to take effect on Jan. 2 and tax increases that couldseriously dent U.S. growth.

Last week Canada's federal government said its budgetdeficit last year was slightly bigger than forecast and blamedthe economic crisis in Europe as well as a patchy U.S. recoveryfor a drop in revenues.

Few analysts believe third-quarter growth will be anywherenear the Bank of Canada's latest forecast of 2.0 percent.

"The slide in imports points to softness in domesticspending in the third quarter, with the volume of machinery andequipment imports down at a 10 percent annualized rate so far inthe third quarter, pointing to a pullback in capital spending,"said Doug Porter, deputy chief economist at BMO Capital Markets.

The Canadian dollar strengthened to a session high againstits U.S. counterpart on Thursday, in part because U.S. joblessclaims fell to the lowest level in more than four years.

The Canadian currency was trading at C$0.9777 tothe greenback, or $1.0228, compared with C$0.9798, or C$1.0206,minutes before the data was released. Two hours later it was atthe same level.

The gloomy imports data deflected attention fromdisappointing export figures. Canada, as a major trading nation,depends heavily on its export sector.

Exports dropped 0.1 percent to C$37.47 billion. A 0.7percent decrease in prices offset a 0.7 percent increase involumes.

Exports of industrial goods fell by 6.1 percent, whileshipments of energy rose by 5.5 percent.

"The recent weakness in exports suggests that Canada'seconomy may have come close to stagnating in the third quarter,"said David Madani, Canada economist at Capital Economics.

"What's more, the outlook for fourth-quarter GDPgrowth is not a whole lot better given the global slowdownunderway," he said in a note to clients.

Exports to the United States - which took 73.8 percent ofall Canadian exports in August - increased by 1.4 percent whileimports from the United States fell by 4.3 percent.

As a result, Canada's trade surplus with the United Statesrose to C$3.48 billion from C$2.02 billion in July, the highestlevel since May when the surplus was C$4.61 billion.

Separately, Statistics Canada said the prices of new homesin Canada rose by 0.2 percent in August, the 17th consecutivemonth-on-month increase.

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For a graphic on Canada new housing prices, click on:

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The Canadian government, which imposed tighter mortgagerules in June, and the Bank of Canada have long expressedconcern that the housing market might overheat. The new housingprice index excludes condominiums, which the government says area particular cause for concern.

A new Canadian composite leading indicator, released for thefirst time on Thursday, showed a rise of 0.1 percent in Augustand suggested Canada will avoid a recession this year.

It was the launch of the indicator by the private-sectorMacdonald-Laurier Institute, which is trying to fill a void leftafter government agency Statistics Canada canceled publicationof its composite leading indicator in May.

($1=$0.98 Canadian)(Editing by Peter Galloway)

((david.ljunggren@thomsonreuters.com)(+1 613 235 6745)(fax +1613 235 5890)(Reuters Messaging:david.ljunggren@thomsonreuters.com))

Keywords: CANADA ECONOMY/