Sydney (AFP) - Australia's economy unexpectedly contracted by 0.5 per cent in the September quarter compared with the June quarter amid falling government spending and softer trade figures.

This slowed the annual rate of expansion in the three months ended Sept 30 to 1.8 per cent from the same period last year, official data showed Wednesday.

The weaker-than-expected Australian Bureau of Statistics reading marked just the fourth quarter in 25 years that the economy had contracted, underlying the challenges facing a country in transition from a mining investment boom.