The Office for National Statistics (ONS) said the fall in output was largely due to a drop in mining and quarrying, after maintenance delays at the UK's largest North Sea oil field.
The economy had grown by 0.9% in the previous quarter, boosted by the London 2012 Olympic Games. For the whole year, growth was flat. The ONS said that the "bumpy economy" was on a "sluggish trend".
Manufacturing fell by 1.5% in the fourth quarter, the services sector was flat, but construction output rose by 0.3%. George Osborne: "We have the right deficit reduction plan"
Within the manufacturing sector, mining and quarrying output fell by 10.2%, the biggest decline since records began in 1997, driven by disruption to North Sea oil and gas fields.
The Buzzard oil field, about 100 kilometres north east of Aberdeen, was shut in early September for maintenance work that was expected to take about 28 days, according to reports.
But Buzzard resumed production in early November, and it was not until the end of that month that full capacity was reached. Buzzard, run by Nexen and with BG Group a 21.7% shareholder, is one of the biggest North Sea fields to be developed in 10 years.
The field holds enough crude potentially to deliver about 10% of the UK's annual forecast oil demand. Nexen declined to comment on the maintenance work's impact on the GDP figures, but added: "The shutdowns occur every five years, are planned, and are required in order to comply with regulatory requirements. The shutdowns enable us to repair and upgrade equipment that cannot be accessed when the facilities are operating."
If oil and gas extraction were excluded from the overall gross domestic product (GDP) calculations, then the data would have shown that the economy shrank by only 0.1% in the fourth quarter, the ONS said.
GDP is the sum of all goods and services made in the economy.
This is the first estimate of how the economy performed in the fourth quarter, and is subject to at least two further revisions as more data is collected.
Chancellor George Osborne said the figures were a reminder that the UK faces "a very difficult economic situation".
He described them as "a reminder that last year was particularly difficult, that we face problems at home with the debts built up over many years, and problems abroad with the eurozone, where we export many of our products, deep in recession".
"Now we can either run away from those problems or we can confront them. And I'm determined to confront them so we can go on creating jobs for the people of this country," Mr Osborne said.
But Labour's shadow chancellor Ed Balls said: "Today's news confirms what business leaders, retailers and families have known for many months - that depressed confidence and a chronic shortage of demand mean our economy continues to flat line.
"This government's failing plan has now seen our economy stagnate for over two years and borrowing is now rising as a result."
Frances O'Grady, general secretary of the TUC, said: "We are now mid-way through the coalition's term of office and its economic strategy has been a complete disaster.
"The economy has grown by just 1%, real wages have fallen, and the manufacturing and construction sectors have shrunk. We remain as dependent on the City as we did before the financial crash."
If the economy were to also shrink in the first three months of 2013, then the UK would re-enter recession, defined as two consecutive quarters of contraction.
2013 UK growth forecasts
—Office for Budget Responsibility: 1.2%
—National Institute for Economic and Social Research: 1.1%
—International Monetary Fund: 1%
—Organisation for Economic Co-operation and Development: 0.9%
The CBI business group said it expected growth "to continue to be fairly flat through the winter but momentum will gradually build later in the year, as the global economy picks up a little and confidence lifts".
Capital Economics believes another contraction in the first quarter is "quite possible... especially given the snow disruption".
However, the Federation of Small Businesses (FSB) said that while the economy was struggling to maintain momentum, its research showed that small firms were slightly more confident going into 2013 than they were going into 2012.
The Office for Budget Responsibility (OBR), the government's independent financial watchdog, has forecast growth of 1.2% this year, slightly above most other independent forecasts.
Earlier this week the International Monetary Fund (IMF) cut its growth forecast for the UK to 1% from 1.1%, but this is a rosier picture compared with its outlook for the eurozone, which it expects to shrink by 0.1% this year.
The ONS data for the fourth quarter showed the drop-off in activity in the services sector following the end of the Olympics and Paralympics.
Services make up about three-quarters of the UK's economic activity. In the third quarter of the year - when the Olympics and Paralympics took place - the sector grew by 1.2%.
The ONS said there was some evidence of "fallback" in the fourth quarter, seen in the hotel and restaurant industries and in land transport.
The biggest impact, though, was in sports activities, amusement and recreation, which dropped 22.5%. This was mainly due to increased ticket sales for the Games in the third quarter, and contributed 0.2 percentage points to the fall in overall GDP in the fourth quarter.
Across the year as a whole, services grew by 1.2% , while total industrial production fell by 2.5% and construction dropped by 9.3%.
Lee Hopley, chief economist at EEF, the manufacturers' organisation, said there were "no positive takeaways" from the figures.
The textile firm surviving the downturn
"Even assuming some unwinding of activity from the Olympics boost in the previous quarter, this still leaves no real signs of underlying growth in the economy.
"The news from industry was particularly weak, with November's sharp drop on output contributing to a rather grim fourth quarter and leaving the overall picture for manufacturing in 2012 the weakest since 2009."
Economists at IHS Global Insight noted that GDP in the fourth quarter of 2012 was 3.3% below the peak level seen in the first quarter of 2008. They estimate that it will not return to that level until the first half of 2015 - a gap of seven years.
The government's economic policies came under focus on Thursday when the chief economist at the International Monetary Fund (IMF) said that the chancellor should consider slowing down austerity measures in his March budget, because of their effect on growth.
"We think this would be a good time to take stock," Olivier Blanchard told BBC Radio 4's Today programme. But Mr Osborne later rebuffed Mr Blanchard's advice. Speaking at the World Economic Forum in Davos, he said that spending cuts must continue if the government is to retain its credibility.
"We have a credible and flexible debt reduction plan. That credibility is very hard won and easily lost," he said. However, Deputy Prime Minister Nick Clegg has said that the coalition made a mistake in cutting back capital spending when it came to office.
He told The House magazine that ministers had reassured themselves at the time that the reduction was in line with plans drawn up by Labour. But they now realised investment in infrastructure was crucial for economic recovery, he added.
When asked about Mr Clegg's views, Mr Osborne responded: "What Nick Clegg has said is that capital investment is important and I agree with that, which is why we have added £20bn of capital investment to our plans over the last couple of years.
"But you can only do that if you have convinced the world that you can pay your way - that investors have confidence in the UK. We've got that confidence."