Wet weather and political uncertainty have contributed to the economy's first contraction in more than five years, but economists say a recession is unlikely.
Gross domestic product declined by 0.5 per cent the September quarter, cutting economic growth to 1.8 per cent in the 12 months to September, the slowest rate of growth since the global financial crisis.
The quarterly contraction was caused by weakness in many areas, most notably a fall in government spending, weaker housing investment and a drop in net exports.
Housing activity was hampered by wet weather, the Australian Bureau of Statistics said, while economists noted the impact of July's federal election, the fallout from the UK Brexit vote and the US presidential election race on consumer and business confidence.
Commonwealth Bank senior economist Michael Blythe said a slower annual rate of growth was more consistent with the recently softening labour market.
"The economy may have completed 25 years of continuous economic growth in 2015/16. But it started 2016/17 with a whimper rather than a bang," he said.
But he added that the latest data "looks more like a pothole rather than the start of something more sinister".
AMP Capital chief economist Shane Oliver also said it was unlikely Australia was headed for a recession - two consecutive quarters of economic decline - as he expects a rebound in growth in the December quarter.
Export volumes are set to rise, along with retail sales, non-residential building approvals, government investment and home construction, he said.
"A lot of the factors which drove the weak third quarter outcome will not repeat in the fourth quarter GDP numbers," Dr Oliver said.
"Weak September quarter GDP partly looks like payback for stronger than expected GDP growth over the year to the June quarter of 3.1 per cent."
The Reserve Bank predicted a downside surprise in the figures, but many economists said the size of drop will mildly increase the central bank's bias towards cutting rates.
Citi economists said the economy's decline, and apparent need to boost public spending, would put the federal government's fiscal strategy under pressure.
"With economic growth well below trend and interest rates already low, the case for fiscal tightening needs to be revisited," they said.
Royal Bank of Canada chief economist Su-Lin Ong warned households are drawing down on savings, and any shock to house prices from looming supply increases in 2017 could weigh on economic growth.
"Some ripple effect is likely although more difficult to assess," Ms Ong said.
"We remind readers that household consumption is the biggest contributor to growth and accounts for almost 60 per cent of GDP. "
