Nov. 23 (Bloomberg) -- Colombia’s central bank unexpectedly cut its benchmark interest rate to a record low as policy makers seek to take advantage of below-target inflation to give an extra boost to a sluggish economic recovery.

The seven-member board, led by bank chief Jose Dario Uribe, lowered the interbank rate a half-point to 3.5 percent after holding last month. Twenty-four of 33 economists surveyed by Bloomberg had expected the bank to keep rates unchanged, while four forecast a half-point cut and five predicted a quarter- point reduction.

Policy makers have slashed borrowing costs nine times in less than a year in a bid to bolster consumer spending after the global financial crisis helped push the economy into recession in the first quarter. The combination of falling inflation expectations and decade-low retail sales prompted the bank to cut borrowing costs to spur lagging consumer demand, said Daniel Velandia, chief analyst at Bogota brokerage Ultrabursatiles SA.

“Last week’s report showed a very strong and unexpected drop” in retail sales for September, said Velandia, who predicted a quarter-point reduction at today’s central bank meeting. “Given inflation expectations and prospects for growth, there was room to cut.”

Retail sales fell 7.3 percent in September, exceeding economists’ forecast of 0.3 percent. The decline was the biggest since at least 2000.

Industrial Output

Industrial output declined 3.8 percent in September after a revised 3.4 percent decline a month earlier.

Policy makers pushed lending rates up to 10 percent last year to battle a surge in inflation, which accelerated to an annual rate of 7.9 percent in October 2008.

Since then, the bank’s rate cuts have helped foster a recovery in credit and boost consumer confidence. At the same time, inflation eased to an annual pace of 2.7 percent last month, the lowest since the 1950s.

“Annual inflation decreased in October more quickly than expected,” Uribe said today after the decision. “The available information through September doesn’t show new declines in economic activity in the country, but neither does it show a vigorous recovery.”

The bank set its 2010 inflation target at 2 percent to 4 percent, lower than the target range of 4.5 percent to 5.5 percent for this year.

Inflation will slow to 2.5 percent by year-end, according to a monthly central bank survey of economists taken Nov. 9. The survey’s result for 2009 has fallen for 10 straight months since the 5.26 percent forecast in January.

Venezuela Risk

A deepening political dispute that has undercut trade with Venezuela is the “greatest risk factor” for Colombia’s economic expansion, according to Velandia.

Venezuelan President Hugo Chavez in July pledged to end imports from Colombia, partly in response to a plan to allow the U.S. military to use Colombian bases for anti-drug operations.

Earlier this month, Chavez told his troops to prepare to defend Venezuela against a possible war with Colombia, and Venezuelan soldiers on Nov. 19 blew up two foot bridges connecting the countries. Colombia mobilized its armed forces to monitor the shared border.

Exports to Venezuela, Colombia’s second-biggest trading partner, fell 50 percent in September from the same month last year, according to the national statistics agency.

Sales to the neighboring country are likely to fall more than 20 percent this year, Uribe has said.

Today’s rate cut “seeks to firm up the economic recovery and reduce the negative effects from the fall in trade with Venezuela,” Uribe said.

Money Supply

Some policy makers at last month’s meeting expressed concern that declines in money supply and credit could affect future monetary policy decisions, according to minutes posted on the bank’s Web site.

“Recent figures for inflation and economic activity support the possibility of a looser monetary policy,” German Verdugo, head analyst at Bogota-based brokerage Correval SA, said in an e-mailed note.

“The bank needs to keep its foot on the accelerator,” Verdugo said. “The recovery is lagging.”

President Alvaro Uribe, who may run for a third term next year, said last month that a rally by the Colombian currency has caused exporters to cut jobs as they get fewer pesos for goods such as flowers and coffee sold abroad.

Colombia on Oct. 30 reported an urban jobless rate of 12.9 percent for September, compared with an 11-month low of 10.4 percent in November last year.

Peso Rally

The central bank last month agreed to buy U.S. dollars and government peso bonds to inject liquidity into the market ahead of the holiday season. Those measures helped stem gains in the peso, which has strengthened 14 percent this year and 33 percent since early March.

Bank chief Uribe didn’t say today whether the bank has completed any purchases of dollars or peso bonds.

The government also has suspended dollar sales in the market for the remainder of the year to weaken the currency.

South America’s fourth-biggest economy will likely recover in 2010, with expansion in the lower half of the bank’s target range of 2 percent to 4 percent, after registering zero growth this year, the central bank’s Uribe said on Nov. 9.

The economy will probably grow 0.5 percent in the second half of 2009, he said.

Meanwhile, lower crop output due to dry weather caused by the El Nino effect may increase food prices through the first half of next year, said Alvise Marino, an emerging markets economist for New York-based research company IDEAglobal.

“If they over-stimulate the economy, the bank would be forced to raise rates at a much quicker pace next year to stem inflation, and that would be detrimental,” said David Duarte, a Latin America economist at 4Cast Inc. in New York.

To contact the reporters on this story: Helen Murphy in Bogota at hmurphy1@bloomberg.net; Alexander Cuadros in Bogota at acuadros@bloomberg.net

Last Updated: November 23, 2009 19:56 EST