OTTAWA - Canada's trade deficit narrowed sharply in September from a record large gap in August thanks in part to a comeback in auto exports and growing sales to non-U.S. markets, Statistics Canada said on Friday.

The trade shortfall shrank much more than expected to C$927 million ($883 million) in September from C$1.99 billion in August. The consensus forecast was a C$1.75 billion deficit.

During the global recession, Canadian exporters have been slammed with anemic demand in their top U.S. market combined with a sharp appreciation in the Canadian dollar versus the greenback.

The auto industry came to the rescue in September and that will boost economic growth that month, analysts said.

It suggests net trade will provide a major boost to Canadian economic activity in September, said Millan Mulraine, economics strategist at TD Securities.

The Canadian dollar extended gains following the trade data, hitting a session high of C$1.0492, or 95.31 U.S. cents, up from C$1.0514, or 95.11 U.S. cents, just before the data.

However, import growth still outstrips export growth at annualized rates so trade will detract from third-quarter growth rather than help it.

The report also suggested businesses have been busy reaching out to new markets to compensate for U.S. weakness.

The big story in this report was Canada's diversification away from the United States, said Benjamin Reitzes, economist at BMO Capital Markets.

As U.S. consumption is likely to lag the global recovery, a shift toward other markets will be a key to Canadian exporters' success, he said.

Exports jumped 3.5 percent in the month, the third increase in four months as the country pulls out of a recession.

A 15.8 percent leap in exports of automotive products led the gain thanks to new models of passenger cars and factories resuming production after summer shutdowns. Exports also grew for industrial goods and materials, and machinery and equipment while energy exports fell.

Imports fell 0.1 percent in September from August.

Exports to the U.S. market inched up by only 0.5 percent as auto sales were offset by weak energy prices.

Exports to non-U.S. countries, particularly the European Union, soared 12.4 percent. As a result, Canada's trade surplus with its neighbor shrank to C$2.1 billion from C$2.3 billion in August and its deficit with the rest of the world narrowed to C$3 billion from C$4.3 billion.

Despite the diversification, Canada still ships about three-quarters of its exports to the United States. Economists predict more trade deficits in months to come due to the strong Canadian dollar and weak U.S. consumer spending, saying the domestic side of the economy will be the motor of growth.

Canada is now learning what it feels like to be tied to the hip of an ailing trading partner with a currency that is again sitting at overvalued levels, said Andrew Pyle, wealth advisor at ScotiaMcLeod in a note. ($1 = $1.05 Canadian) (Editing by James Dalgleish)

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