Nov. 6 (Bloomberg) -- Chilean consumer prices fell at the fastest pace since 1934 in October, 12 months after peaking at a 14-year high.

The cost of living dropped 1.9 percent from a year earlier, the National Statistics Institute said today in Santiago. Prices were unchanged from September, the institute said.

“Inflation is the lowest in decades, but there are lots of elements that suggest we’ve reached a floor,” said Rodrigo Aravena, an economist at Banchile Inversiones in Santiago. “Inflation in Chile is going to start rising and we should be back to positive year-on-year figures by February.”

Chile’s central bank has slashed interest rates to a record low of 0.5 percent and vowed to keep them there for as long as needed to push inflation back toward its 3 percent target. The bank probably won’t increase borrowing costs until after March 2010, bank President Jose De Gregorio said last month.

The annual pace of deflation accelerated from 1.1 percent in September. In October, both the monthly and annual results matched the median forecasts of economists surveyed by Bloomberg.

Traders in the interest-rate swaps market expect inflation to accelerate to about 1.8 percent in a year’s time, according to Bloomberg calculations of the so-called breakeven inflation rate. Breakeven inflation shows the extra yield investors demand to receive a fixed payment instead of a payment indexed to inflation for the same period of time.

Inflation Outlook

Prices will rise 2.5 percent next year as the economy expands 4.3 percent, according to a central bank survey of economists published last month.

Chile’s economy shrank 1.1 percent in the 12 months through September after demand for the South American country’s exports, led by copper, collapsed late last year.

Gross domestic product contracted year-on-year in the first and second quarters of 2009 and monthly data published yesterday implies that activity declined 1.3 percent in the third quarter. The central bank will publish final figures for third-quarter GDP on Nov. 18.

De Gregorio and the central bank have repeatedly warned that traders think the bank will raise rates faster than the central bank expects to do so.

Chile’s central bank rate-setting committee is due to meet on Nov. 12. The five-member policy board will leave the benchmark rate unchanged, according to the unanimous forecast of eight economists surveyed by Bloomberg.

The central bank may start cutting back on cheap loans for other lenders, Aravena said. It has already started phasing out access to dollar financing for Chilean banks that it put in place during the credit crunch last year.

“The central bank should start preparing the way for the rate to rise no later than April next year,” Aravena said.

To contact the reporter on this story: Sebastian Boyd in Santiago at sboyd9@bloomberg.net

Last Updated: November 6, 2009 10:56 EST