Faced with a sharp sales decline and excessive inventories, North American auto production turned sharply lower in December, and has been virtually shut down in January, according to a report released Friday by Scotia Economics.

“Vehicle output in Canada, the United States and Mexico will plunge nearly 50% below a year earlier in the opening month of 2009, as many companies have extended their holiday shutdowns through most of January,” says Carlos Gomes, senior economist and auto industry specialist, Bank of Nova Scotia. “We estimate that these cutbacks will reduce North American vehicle output to less than an annualized eight million units in January, a sharp fall-off from a full-year 2008 total of 12.9 million.”

Output at the “Detroit Three” will fall roughly 65% below a year earlier in January, as most of their plants in Canada and the U.S. will remain closed through month-end. However, the shutdowns are not limited to the Detroit automakers. After a 30% year-over-year decline in production this month, Asian and European manufacturers will ramp up output faster than the North American automakers. As a result, the “New Domestic” automakers are scheduled to produce more vehicles in North America in the first quarter than the “Detroit Three”.

“We estimate that the cutbacks in vehicle production will reduce U.S. economic activity by roughly two-and-a-half percentage points in the first quarter, an impact similar to what occurred in the final months of 2008,” says Gomes. “In Canada, we estimate that lower vehicle and parts output will subtract more than one percentage point from economic growth in the opening months of 2009.”

Lower vehicle production is taking a big toll on parts suppliers. Employment in the sector has been slashed by more than 22,000 in Canada since late 2003.

“Aside from the sharp decline in industry volumes, Canadian suppliers have lost significant market share in recent years. We estimate the value of Canadian-made parts in each North American-built vehicle has dropped to less than $1,700 from more than $2,000 as recently as 2004,” adds. Gomes.

The sharp cutback in first-quarter vehicle assemblies points to the current inventory adjustment running its course by April. Inventories will likely drop to less than two million units by the end of March, 24% below a year earlier and roughly 35% below the average first quarter of the past decade.

U.S auto sales plunged 35% below a year earlier in December, and remain just above an annualized 10 million units, the lowest level since the early 1980s. The sharp decline in recent months reduced full-year 2008 sales to 13.2 million units, an 18% plunge from 2007, and the lowest annual total since 1993.

The downturn in Canadian auto sales also accelerated in December, with purchases slumping 21% below a year earlier. Scotia Economics estimates that purchases fell below an annualized 1.30 million units in December, significantly weaker than the 1.67 million unit average through November. It expects sales to remain weak in the first half of 2009 and are forecasting full-year 2009 purchases to slump to 1.475 million units, the lowest annual total since 1998.