(Adds analyst comment, details)
By Andrew Hay
MADRID, Nov 14 (Reuters) - Spanish GDP fell 0.2 percent in the third quarter, sending the euro zone's fourth-largest economy into contraction for the first time in 15 years, National Statistics Institute (INE) figures showed on Friday.
The widely-expected drop in quarter-on-quarter GDP compared with 0.1 percent growth in the second quarter.
The fall was driven by dwindling domestic demand as the collapse of a decade-long housing boom coincided with global credit restrictions, INE said.
Lower spending by firms and households was compensated in part by weaker imports which meant Spain's foreign trade account made a net contribution to growth.
Spain now faces the risk of prolonged recession that drags on through 2009 and sends unemployment over 20 percent from a current 11.3 percent, analysts said.
"Spain's heading into a full blown recession," said Jose Garcia Zarate at the 4Cast consultancy in London. "The major factor has been domestic demand and private consumption and this will only get worse next year as unemployment rises."
A house construction and property boom collapsed this year after chronic over-building which has left up to 1.5 million new homes standing empty as prices rapidly fall.
The construction decline has a long way to go, given house starts are down 50 percent while housing investment has only fallen about 5 percent as firms finish off projects already on their books, said BNP economist Dominic Bryant.
"It's simply the scale of adjustment that has to take place in Spain, I don't think people have got their heads round it yet," said Bryant.
In just over a year, Spain has gone from creating over a third of all new jobs in the European Union to losing more than France, Britain and Italy put together.
During October, 193,000 people, or 6,214 a day, registered as jobless in Spain, a number comparable with that of the United States which has a workforce over 7 times larger.
The last time the Spanish economy shrank was in the second quarter of 1993, the last of four quarters of recession during Spain's previous property crisis.
Annual growth has also fallen to its lowest level in 15 years, declining to 0.9 percent in the third quarter, INE said.
Glimmers of hope are rapidly falling inflation and European Central Bank interest rate cuts which boost disposable income for mortgage holders, most of whom hold loans on variable rates.
Spain's strictly regulated financial system has resisted market turmoil better than most others in Europe but faces a default rate that is expected to triple by late next year.
A long term challenge is to overhaul an outdated economic model which has long depended on cheap credit and creation of millions of low-skill construction and service jobs.
"With a gradual recession that lasts a long time there is going to be a temptation to keep what we've got," said economics professor Pere Puig at Spain's Esade business school. (Reporting by Andrew Hay; Editing by Mike Peacock)