* 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 August dropped by a surprising 3.1 percent from July, suggesting the Canadian economy is struggling to cope with weak international markets and slowing domestic demand.
The fall in imports reported by Statistics Canada on Thursday overshadowed a bigger drop than expected in the trade deficit, to C$1.32 billion ($1.35 billion) in August from a record C$2.53 billion in July. Exports slipped by 0.1 percent.
The trade deficit, the fifth in a row, was smaller than the C$1.90 billion shortfall predicted by market analysts.
The value of imports fell to C$38.79 billion on widespread declines in every sector except energy, while volumes were down 2.2 percent. It was the largest month-on-month fall in imports since the 4.4 percent drop recorded in May 2009.
"That's the big story here. The drop in imports was broadly based and could signal weakness in the domestic economy both in terms of soft consumption and weak business investment," said Scotia Capital economists Derek Holt and Dov Zigler.
"That would fit concerns regarding business confidence heading into a highly active global events calendar including the U.S. fiscal cliff," they said in a note to clients.
The "fiscal cliff" refers to the combination of spending cuts set to take effect on Jan. 2 and tax increases that could seriously dent U.S. growth.
Last week Canada's federal government said its budget deficit last year was slightly bigger than forecast and blamed the economic crisis in Europe as well as a patchy U.S. recovery for a drop in revenues.
Few analysts believe third-quarter growth will be anywhere near the Bank of Canada's latest forecast of 2.0 percent.
"The slide in imports points to softness in domestic spending in the third quarter, with the volume of machinery and equipment imports down at a 10 percent annualized rate so far in the 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 against its U.S. counterpart on Thursday, in part because U.S. jobless claims fell to the lowest level in more than four years.
The Canadian currency was trading at C$0.9777 to the greenback, or $1.0228, compared with C$0.9798, or C$1.0206, minutes before the data was released. Two hours later it was at the same level.
The gloomy imports data deflected attention from disappointing 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 0.7 percent decrease in prices offset a 0.7 percent increase in volumes.
Exports of industrial goods fell by 6.1 percent, while shipments of energy rose by 5.5 percent.
"The recent weakness in exports suggests that Canada's economy 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 GDP growth is not a whole lot better given the global slowdown underway," he said in a note to clients.
Exports to the United States - which took 73.8 percent of all Canadian exports in August - increased by 1.4 percent while imports from the United States fell by 4.3 percent.
As a result, Canada's trade surplus with the United States rose to C$3.48 billion from C$2.02 billion in July, the highest level since May when the surplus was C$4.61 billion.
Separately, Statistics Canada said the prices of new homes in Canada rose by 0.2 percent in August, the 17th consecutive month-on-month increase.
The Canadian government, which imposed tighter mortgage rules in June, and the Bank of Canada have long expressed concern that the housing market might overheat. The new housing price index excludes condominiums, which the government says are a particular cause for concern.
A new Canadian composite leading indicator, released for the first time on Thursday, showed a rise of 0.1 percent in August and suggested Canada will avoid a recession this year.
It was the launch of the indicator by the private-sector Macdonald-Laurier Institute, which is trying to fill a void left after government agency Statistics Canada canceled publication of its composite leading indicator in May.
($1=$0.98 Canadian) (Editing by Peter Galloway)
Keywords: CANADA ECONOMY/